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November 6, 2019

Compensation 2020: The Perfect Storm

Looking toward 2020 compensation, the perfect storm is brewing. There are several regulatory clouds on the horizon, each of which is its own concern. Add to that the free market clouds and we have a combination of events that could create the perfect storm, the wrath of which can leave even the best designed compensation structures in tatters. 

Labor Market Outlook

With an October unemployment rate of 3.6%, there are currently 5.9 million unemployed persons in the US. Contrast that with 7.1 million job openings, and there are more job openings than job seekers. To call this labor market tight seems like an understatement.

Typically, we should expect that the price (i.e., wages) for a resource (i.e., workers) would go up when demand is high and supply is low. So far, that’s happened some but not much. The latest Bureau of Labor Statistics data shows that employer wages have risen 2.9% over the past 12 months which is where it has hovered for the past year.

The question going into 2020 is whether we will see accelerated wage growth in a persistently tight labor market. This is the first ominous cloud heading into 2020.

Minimum Wage and Then Some

Depending on where you have operations, this may be a big consideration for 2020 and beyond. States and municipalities are increasingly setting their own minimum wage rates to exceed the federal minimum wage of $7.25, which has not changed in a decade. $12.00 or $15.00 per hour are popular targets, which are phased in over multiple years. Complying with these changes is only the first challenge — the first, light drops of rain. It’s the second- and third-order effects that pose the significant concern.

Maintaining Wage Premiums

Consider an employee currently earning a $2.00 per hour premium over minimum wage. Depending on the specifics of the state, this premium will be significantly reduced if not completely eliminated in a few years. Employers will seek to maintain the wage premium, at least to some extent, to retain skilled employees and reward the skill premium.

A popular strategy among clients we work with is to thoughtfully “waterfall” the increase through some set point in the salary structure. This can be structured by increasing percentages tied to wage tiers or to salary grades, depending on the nature and structure of the organization.

Bordering States

If you are in a state that still has the federal minimum wage in place and you think your organization is safe from minimum wage pressure, think again. If you have operations near a bordering state (or municipality) with a higher minimum wage, expect to see low-wage employees seek employment across state lines. 

Let’s look at an example. The year is 2024 and Missouri now has a $12.00 per hour minimum wage. A worker in Kansas City, Kansas has the opportunity to work for a $7.25 per hour wage in Kansas or can seek employment across the state border — potentially literally across the street — for an additional $4.75 per hour.

Other Factors

It’s also reasonable to assume that organizations will implement measures that reduce labor hours to offset increased labor costs. This could be a reliance on greater automation or even the movement of operations to different states (e.g., across state lines).  

Traditionally we evaluate published survey data to understand wage trends, but it will take some time for that data to emerge, and around the time that it does new minimum wage increases will be upon us again. Building a strategy around minimum wage requires anticipation and prediction in the short term

Pay Equity

Another consideration is evaluating pay equity practices and addressing any discovered areas of inequity. While pay equity laws have been in effect since the 1960s, news coverage and state law changes are placing a self-evaluation top-of-mind.

States are increasingly going it alone with pay equity laws that tend to involve some combination of salary history bans, changes to the definition of comparator groups (e.g., equal pay for equal work to equal pay for similar work) or enacting reporting requirements.

This is an area where it’s best to be proactive. It’s better to conduct a self-audit before being required to do so in the face of a pay discrimination claim.

Fair Labor Standards Act (FLSA)

The Department of Labor (DOL) completed the rulemaking process for FLSA overtime changes. A summary of the changes can be found on the DOL’s website where they estimate that an additional 1.3 million workers will be eligible for overtime effective January 1, 2020. With an estimated total labor force of 160 million, this change affects approximately 0.8% of workers.

Many organizations will be affected by these changes, but rare are the organizations that will be significantly affected. Nonetheless, organizations will need to do their due diligence and evaluate potential areas of non-compliance and either absorb some additional overtime costs or increase wages to surpass the new salary threshold. 

Pay Compression

The final storm cloud is pay compression. One form of pay compression is when there is little to no pay differentiation between newly hired employees and their longer tenured peers. As wages rise in the broad labor market, applicants will have higher salary expectations.

This dynamic can become a drag on the hiring process. Many a hiring manager has been faced with the dilemma of passing on a qualified candidate because the candidate’s salary expectations are above that of other peer employees. To avoid the pay compression issues, they pass on the hire.

There are a few solutions to address this. One on-the-spot solution is to have policies that allow for internal adjustments to salaries when compression situations arise. Another solution is to award an increase based on a merit matrix, where the increase amount is determined based on the intersection of performance and salary range placement. This is a great way to avoid compression in the first place as it quickly ramps up pay for employees low in the pay range.

In Closing

Organizations face a number of pay-related challenges going into 2020. A host of regulatory concerns — minimum wage, pay equity and overtime — need to be contented with. Particularly in the case of minimum wage, the downstream effects should be of equal concern. Add to this the tight labor market and growing wages overall and you have the perfect storm leading to the destruction of your salary structure and salary budget. The sooner you can evaluate each of these threats and start strategizing solutions, the better you’ll be able to weather the storm.

Your Team

Don’t hesitate to reach out to Joe Rice with your questions and for additional information. You can reach Joe directly at 314.590.4070 or jrice@cbiz.com.

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