12 Jan Don’t Confuse the “Cost of Living” with the “Cost of Labor” in Salary & Pay Planning
By Susan Malanowski of Wilson Group
In working with compensation consulting clients in the development and management of base pay programs, at Wilson Group, we frequently hear about or receive questions about the geographic “cost of living” being used to determine or justify salary and pay rates. For example, “our Stanford, CT location has a much higher cost of living than the headquarters office in Billerica, MA”. Unfortunately, this can sometimes be based on employee experience and not actual cost of living information. This demonstrates confusion about what impact the cost of living has on pay levels. In addition, annual salary increases are sometimes referred to as “cost of living increases”.
- What is “Cost of Labor”?
Cost of labor is what an employer pays to attract and retain an individual with the education, experience and skills needed to do a job. This is usually based on supply and demand in that location. Compensation professionals utilize ongoing employer-completed salary surveys (compensation market data) to establish and adjust pay ranges. Therefore, what employers pay in each geographic area reflect what other employers in that area are paying. Over time, pay for jobs increase when supply is low, and demand is high. When the demand drops, and the supply is high, the pay does not increase but can decrease.
- What is “Cost of Living”?
“Cost of living is the amount of money needed to sustain a certain level of living, including basic expenses such as housing, food, taxes and health care” (Investopedia). Over time the cost of living has both increased and decreased. However, most don’t realize that it can decrease, and many employees still expect an annual increase to “maintain the same standard of living”.
Often, cost of living is higher in major metropolitan areas than the cost of labor. The Economic Research Institute Geographic Assessor provides differentials for both cost of living and cost of labor by salary levels compared to a US average.
As an example, the following table was created from our ERI subscription of Geographic Assessor. It compares the salary rate of $75,000 between the two cities of Newport News, Virginia and San Diego, California compared to the US Average and each other. It shows that the cost of labor is about 13% more in San Diego ($84,706) than Newport News. However, the cost of living in San Diego is significantly more than Newport News or 64%. If you want to live in a city where the cost of labor and cost of living is equal, Newport News is the place to be.
It is a prevailing practice or best practice for employers to use compensation market data to establish pay ranges, differentials between locations and establish salary increase budgets, not the cost of living. In these examples above, in developing a salary range for the two cities, we would recommend a 10-15% differential for these two cities for this pay level. We would not base it on the 64% differential in the cost of living.
- What about Full-time, Remote Workers?
One of the challenges for employers in developing geographic salary ranges are how to pay remote workers who do not work near a company facility. For example, the company headquarters is in Newport News and there is a second major location in San Diego. What if 20% of the rest of the workforce work from home and live in 6 different states? It would seem appropriate to use the range closest to the employee’s remote location’s “cost of labor”. However, some argue that with the benefit of not having to commute or relocate, the home location should not make a difference and they should be paid within the same geographic pay range as the US average or headquarters (Newport News for example). Statistics provided by Remote.Co (https://remote.co/10-stats-about-remote-work/) indicate “60 percent of remote workers in the survey said that if they could, they would leave their current job for a full-time remote position at the same pay rate.” Compensation that reflects the local labor market or cost of labor is the best attraction and retention tool. Certainly, there are other types of remote workers, such as those that relocate for personal reasons and are retained as remote workers, that may be treated differently. As the trend to have remote workers continues to grow globally, the approach may change in the future. In comparison, sales people were the first examples of remote workers. In our experience base salaries tend to be consistent on a national/country basis, not locally.
- Why is this Important?
Having a market based philosophy for establishing compensation is important in a competitive labor market. Being able to communicate this to employees (pay transparency) is not only a good practice that can improve employee satisfaction with pay but is important with pay equity laws being enacted in Massachusetts, California, and New York.
Retaining references to cost of living increases implicitly means entitlement. Increases in employee’s pay, if not based on performance, market or increases in job responsibilities, can be referred to as general increases. A general increase is the same percent increase given to every employee (except if an employee’s pay is above the pay range maximum or the employee is under a performance improvement plan).
If you need help with your compensation philosophy, base pay program or geographic pay ranges, we’re here to help.