Compensation Efficiency in a Tight Labor Market
In a job market where there are currently more job openings than job seekers, it is increasingly important for organizations to make efficient compensation decisions. This means not paying your workforce too much, but also not paying uncompetitive wages that cause key employees to look elsewhere.
Since labor is generally a company’s largest expense, higher-than-necessary wages could affect company profitability or result in higher prices for customers. In fact, labor typically represents greater than 60% of total costs. Even overpaying by a few percentage points could represent thousands of dollars in increased expense. The chart to the right illustrates labor as a percentage of total costs in the U.S. over approximately the last five decades.
At the opposite end of the spectrum, paying wages that are below market can result in high turnover. In our experience, it is often the top talent that leaves, since those workers will likely have an easier time landing a new job. Conversely, lower performers tend to remain, since their external job prospects are not as good. Recruiting and training new employees can be very costly, not to mention the loss of knowledge that occurs with the departure of experienced and/or high-performing workers. No company wants to become a training ground for its competitors.
Since there can be significant costs associated with paying too high or too low, organizations should take appropriate steps to benchmark their pay systems to the external market. Using valid compensation data and having a well-designed framework to manage pay are the best ways to ensure that your company can manage labor costs efficiently. We would recommend that you review your pay system annually, especially during times when the labor market is tightening, and wages may be increasing faster than historical averages.
-Dan Steele, POE Group, Compensation Consultant