The land of 3%: Reading the compensation curve

Now, part of what we're paid to do as executives is in planning the ability to predict. We have to predict. Accuracy for prediction and execs is often also a gauge of competence. Now, for CHROs and other HR leaders, the largest line item in their budget is compensation and benefits.

Salary rate increases are a vexing line item in each year, subject to a debate. But very quietly, the market tells us the trends that should make predictions simple. In fact, the data is hiding in plain sight. So we're going to have a simply complicated discussion on compensation. Are you all following me? We have the perfect guest to discuss salary rate increases and budgets. Lori Wisper. Our guest is a managing director for Willis Towers Watson. She joined them 16 years ago, and prior to that was Hewitt.

And prior to that firm, she was an HR leader for total rewards in marquee companies such as Underwriters Laboratories. Now, Willis Towers Watson, I'm sure you all, is one of the most respected consulting and HR service companies in the world, providing thought leadership and sage advice-- get ready. You're about to get some-- sage advice on HR, workforce trends, and technology to thousands of companies via many different practice groups. Lori, welcome to the podcast. Anything you'd like to add about your practice at Willis Towers Watson for our audience?

LORI WISPER: First, let me thank you so much, Elliot, for having me today. It's a pleasure and an honor to be with you. Just to add a little bit, my particular line of business works with, as you said, many, many thousands of companies.

And we try to provide data-driven, insight-led solutions in the areas of people, risk and capital that make organizations more resilient, more effective, and like you said, better able to predict things that they can manage to a more effective degree.

ELLIOT CLARK: So we're going to actually have to talk about the quiet part out loud today.

LORI WISPER: Yes.

ELLIOT CLARK: Let's start with the basic question that everyone, especially employees and you think about everyone but the board are technically employees. Everyone's asking, which is, right now, we are in a period of elevated inflation. Why don't salary rate increases keep pace with the rate of inflation? And if not, why not? It's a big question out there in the business media.

How do you respond to that question when your clients ask you, should we pace to the rate of inflation?

LORI WISPER: Yeah, this one always comes up. You're quite right. And the way that I have managed through articles I've written, through discussions I've had with clients, other talks I've had is to, as you said, simplify it as much as possible.

And when you look at the rate of inflation versus what employees get paid, it comes down to two economic indicators. These are very different economic indicators because they are built off of different things, but people converge them together because they do represent an individual person's buying power.

The two economic indicators are CPI, or inflation, and salary increases that you, like you said, represent the cost of labor. So on the one hand, you have cost of living. On the other hand, you have cost of labor. Cost of living or inflation represents a market basket of goods, the largest of which are housing, food, and energy.

And the cost of labor represented by, as you said, those things we planned for. Salary increases are very, very simply the supply and demand of labor. Two very different things. And both can be different based on different markets, geographically based markets, industry-based markets.

And when you put those things together, what I buy and what I get paid, those two things represent my buying power. That's why it's confusing to people. As an employer, you only look at the cost of labor. Why? Because the way people manage their cost of living is really up to them. Employers don't say to their employees, you have to live here, or you have to purchase this.

Those are individual choices. What I can manage as an employer is what I spend on labor, the cost of labor. So how do I plan for that? What do I look at? I look at indicators that say, what is the supply and demand of labor in the markets in which I compete for talent. And therefore, what do I need to pay to be competitive?

So for example, in early 2020 before the pandemic hit, inflation was 1.4% in January, February, and even into March. The going salary rate increase was somewhere around 3%. And back then, you didn't hear people saying, please match my increase to inflation levels, because the answer would have been fine. But you're going to get 1.4% You're going to get half of what I was planning to give you, right?

Well, that equation flipped a year later in mid June-- in mid 2021 when we had record inflation of 9.2%. I think it was 21 or 22. Forgive me if I got those wrong. The point is, that's when people started to realize, oh my gosh, my salary increase, which is still around 3%. It might have been 3.2 back then, is not keeping up with what I'm buying, which is absolutely true. I'm not going to diminish the fact that things are super expensive.

But it's bad business a max salary budgets to the going rate of inflation. Why is that? Because if I were to pay somebody 9.2% increase starting in June of 22, when inflation went back down to where it is now, which is around 3.5% in the US, you still have that 9.2% increase.

Salary increases are sticky. They get paid, and we don't say, give us that money back because now the cost of living went down, right? They're sticky and they compound over time. So my cost of doing business goes up, and employers cost of doing business goes up over time. And inflation varies quite a bit.

So when people say, oh, but if you're not getting a salary increase that matches your cost of living increase, you're getting a pay cut, that is absolutely false. Pay never goes down. It only goes up. It may not feel that way to any of us, but that is the economics.

ELLIOT CLARK: Do you think employers should spend more time trying to explain the difference between pay and buying power? Because buying power is fungible based on economics. Pay is actually, to your point, always on a rising curve.

LORI WISPER: I have seen that. I have seen some employers try to do that. It's a really big uphill battle. I myself face that same battle because the media so strongly pushes this concept that pay is not keeping up with the cost of living.

And it is intuitive-- it's counterintuitive the argument that I'm making. I realize it. But when you dig into the economics, like you said, the data is there in plain-- hiding in plain sight. It is much more understandable, but you have to really dig for it. The other thing I might add to what we've been talking about is the only thing to correct for overpaying is layoffs.

So that's why it's bad business. We saw this in the tech industry that they hired like crazy. They paid well above market during the e-commerce boom after the pandemic. And then what did we see three, five, years later? We saw layoffs.

ELLIOT CLARK: Well, let's talk about that data that's hiding in plain sight because you make a great point. You have very few good choices if you're going to match the labor supply and demand is different than consumer product supply and demand. If you're going to match inflation, layoffs are not a good choice.

Well, let's talk about the data. What can we learn from the long-term trends about the patterns of salary increases. And how has the change in comp philosophies in areas such as variable comp impacted the trend line in recent years? Now, our audience is a lot of chief HR officers, heads of comp and benefits, et cetera. So what can you tell them about what we actually see in terms of the trend lines?

LORI WISPER: Yeah, those are really good to look at, as you're saying, because they will help inform your planning and they will help you educate both leaders and employees about what they can expect. And what I've seen in looking at over 50 years of salary budget data is the best way I can describe the pattern is a stair step downward.

So we started with very high even double-digit salary increases back in the mid 1970s and early 1980s, you would see 8%, 9%, 10% salary increases, which by today's standards sounds like a king's ransom, right? But at various times throughout those decades when we have had severe economic downturn, meaning recession, those numbers have dropped significantly.

Why? Because of the imbalance between the supply and demand of labor. So when the supply has gone way up, when there's been a recession, and the demand has gone way down, we get this drop in salary increases. And the reality is we never fully recover to that prior high.

And so when I say this stair step downward, you can even pinpoint those economic downturns at various times and show this is where it dropped significantly. And yes, maybe there was a bit of recovery. But it never fully recovered. Actually, it fully recovered once in some 20, 30 years. And that was in 2023 when we had a record number of Americans change jobs.

So we again had this imbalance that the demand for labor was super high, supply not so much. And for the first time, we went back to 4% salary budgets in 2023, for the first time in close to 20 years. We had been in the 3's, what I call the land of 3%. Prior to that-- like if you here's the economic downturn example that I use-- many of us remember the Great Recession of 2008, '09, and '10.

In 2007, salary budgets were between somewhere around 4.5% maybe even getting towards the 5% number that it had dropped from, given a prior recession. And then we had just this severe crisis, huge layoffs everywhere, the housing crisis, the financial institution crisis. And for the first time ever, in 2009, salary budgets dropped below 2%. One survey showed of 1,200 companies showed it was 1.8% in the US for the first time ever. Why was that?

Because half that survey group paid 0. It's the average of all of those companies, right? What we all know, zero increases is not sustainable. It took more than five years to recover to go up around 3% again. We inched our way up over five years from 1.8 to closer to 3. But that's what I'm talking about. We never fully recovered to 4% or above until 2023.

ELLIOT CLARK: And so for the CHROs and the heads of total rewards and comp and benefits that are out there, they really should be looking at that 50-year chart. And I know you have an article coming up very soon. If it's coming, we have the URL in time. We're going to put it up at the end of the podcast so that folks can download that because looking at that 50-year chart does tell a story, and you start to remember, oh, 2008, yeah, that's when all the banks needed bailouts, et cetera.

LORI WISPER: Yes.

ELLIOT CLARK: And you can see that the great resignation-- I don't even that term-- but that pent up demand breaking in '23. You see all of our economic cycles. So let's zoom out for a moment. We hear so much conflicting and confusing economic news. How can a chief HR officer have confidence in predicting economic cycles?

Or alternatively, do you want to comment on this rising argument right now amongst geeks like us. Lori, I think you're a geek like me that economics may now be moving to an event-driven model versus a cyclical model. And does that even matter to comp planning when you live in the land of the 3's? So I love your take on that debate.

LORI WISPER: It's a great question, Elliot. And does it really matter? The answer is, no, I don't think so because there's never an absolute, right? But here's why I say that all executives-- I always talk to my clients about making data-driven decisions. And I am a geek like you, just like you said. I look at the data, and that helps me make the right-- give the right advice to my clients so they can make the right decisions.

And when you look at that, the data we just talked about, and you look at what's happening right now in the labor market, that's where I always start. I start with what's going on in the competitive labor market because that's going to tell me how salary budgets will move.

No other economic indicator will tell as directly as the supply and demand of labor. What's happening in the US right now is something I call equilibrium. You have almost pure balance in the labor market. What do I mean? You have low demand. You don't have a lot of job creation. We've seen that in the monthly Department of Labor reports.

But you also still have really low supply. No one's talking about it because the demand for labor is so low. But we still have worker shortage. We still have demographics that are working against us, a shrinking native population and not also the element of almost zero net immigration.

OK? All those things contribute to the fact that we still have worker shortage, but because we don't have high demand, we've got this equilibrium, which is why the unemployment rate doesn't move much either from month to month. What does that mean for salary budgets? It means they're going to stay relatively stable.

That's why I say start with the competitive labor market. I have leaders, HR and business leaders, saying to me, oh, but Lori, the job market is so bad, why wouldn't the salary budget numbers go down? Well, you're forgetting the supply side. You got to look at both. The other thing is the Great Recession of 2008, '09 and '10 taught us a very important lesson.

They taught us that salary budgets have a bottom threshold, a bottomed-out threshold. The only way we're going to go to a very low number, like we did then, is if a significant number of employers say, I don't have any money, I'm not paying anything this year. I have a zero budget increase or neutral. And that's not going to happen unless we are in dire economic circumstance like we were back then, and we—

ELLIOT CLARK: which we're not.

LORI WISPER: --which we're not. And hopefully, we never get there again. And so you probably shouldn't expect that salary budgets are going to go much below 3%. But just like I said earlier, the only time they went above 4% was one time in the last 20-some years when we had the Great Resignation, as you called it. Is that going to happen anytime soon? Probably not. So we're in this limbo land of 3% to 4%.

ELLIOT CLARK: Well, and it looks that that's where we're going to stay. We're at time. So I'm going to thank you.

LORI WISPER: Of course.

ELLIOT CLARK: I think if I start a series called HR Geeks, you're definitely going to be one of my guests.

LORI WISPER: I'd be honored.

ELLIOT CLARK: There you go, because I do think that the data is the story. And all the comp and benefit leaders out there who are good at their jobs-- and they are. Know this-- but it does help to get the validation externally from firms like Willis Towers Watson.

So I do want to thank Lori Wisper managing director in the compensation, advisory service practice at Willis Towers Watson for taking part in the podcast. For those of you who are listening, if we have it, we're. She has a great article coming out with that 50-year chart, by the way.

LORI WISPER: Yes.

ELLIOT CLARK: So we're going to put the URL up on our screen. If we have it in time for this podcast release, and you can get it off the WTW website, or we can follow up with the folks who listened to the podcast and try to get that out to you. Lori, thanks again for taking part in the podcast, and we're going to have you back sometime soon.

LORI WISPER: I'd love that. And thank you so much for having me.

ELLIOT CLARK: And to our audience, in HR land out there listening in the land of 3%, as we've now dubbed your domain, thank you for your time and attention to the podcast, and we look forward to you joining us on our next HR Today Educational Podcast.