Cost of Labor Versus Cost of Living

There is an important philosophical point that gets raised in virtually every presentation on compensation I make to employees; someone invariably asks the question "What about cost of living?"

The difference between "cost of living" and "cost of labor" is an absolutely critical one, particularly when it comes to compensation philosophy and compensation communication.  Cost of living reflects the cost of goods utilized by a typical consumer, including items such as housing, groceries and transportation.  Cost of labor reflects what a particular geographic market offers as compensation for a specific type of work.

I advise my clients to be very very clear about what their compensation philosophy is, and what their compensation program is designed to deliver, relative to this distinction.  In other words, is the purpose of the compensation program:

a) To reimburse employees for their cost of living?

or

b) To pay employees a competitive wage or salary for the particular jobs they perform and the specific skill/capability sets that they offer to the organization?

I would argue that it is the latter.  To the extent that we allow the phrase cost of living to slip into our communication to employees about their pay packages, we risk the perception that our organizations have made some commitment to do the former.  And that is a step onto a slippery slope. 

So, for example, in communication about adjusting the organization's wage scales and salary structures, I recommend not saying that the adjustment is in response to, or reflects, cost of living.  Rather, say that the decision to adjust these structures is in response to competitive movement of pay levels in the labor market. 

And if your organization is in the habit of providing "across the board" increases to employees (where every employee gets an equal wage or salary increase), I recommend describing the increase as a competitive market increase, a reflection of the rise in the cost of labor within your particular market for talent.  Not a rise in the cost of living.

See the distinction?  I think its a pretty important one.

And, hopefully, the decisions underlying these actions, to adjust wage scales and salary structures, or to provide wage/salary increases, are made in consideration of information on market compensation trends and projections (such as the information provided via WorldatWork, Mercer and other key salary planning studies featured on this blog - under the category of "base salary management"), not CPI data.

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Comments

[Jannine Hemphill]

Hi there. I think you make an excellent point. However, I would like to understand how you make this important distinction when dealing with a "virtual" workforce where the line drawn in the sand that distinguishes "we pay based upon the market indicators of where you work, not where you live" now become one and the same.

[Ann Bares]

Jannine:

Thanks for the comment and question. I think organizations who employ virtual workers have to have a clear and purposeful pay philosophy that addresses this question. That philosophy, and the organization's position on how it pays virtual workers, probably ties back to the rationale and situation that drove it to employ virtual workers in the first place, along with the labor market it faces for this kind of talent.

I can see this going in a number of possible directions, including:

1. Paying workers in line with the labor market where they reside (even if this is high-market locations like New York or Los Angeles), in response to a difficulty in recruiting and retaining the necessary talent - and it being a seller's market.

2. Paying workers in line with the labor market where the organization's offices are located (even if this is a low-market location like Tampa or Greensboro), in response to the fact that these virtual opportunities are in high demand, it is a buyer's market, and the organization is easily able to fill any openings it has.