WHY COST OF LABOR SHOULD GUIDE YOUR COMPENSATION
Ensuring fair staff compensation can be a delicate tightrope walk for organizations. As a labor market leader, your organization wants to attract and retain top-tier talent while staying within the defined compensation budget.
Human resources leaders use a range of factors to set and adjust pay. The two most common factors guiding compensation strategies are the cost of labor or the cost of living. The cost of labor reflects the market value of a specific job. In contrast, the cost of living reflects the expenses that staff need to support a particular standard of living in a given location.
There is an ongoing debate about which factor should hold more weight. Should you base your salary on the market’s value for a role (cost of labor), or should one’s civil status and standard of living dictate pay (cost of living)?
This blog post argues that your staff compensation strategies must be guided by the cost of labor for a fairer and more sustainable approach. Let’s explore why the cost of living is an unreliable benchmark and, more importantly, why the cost of labor should take center stage.
Why the cost of living is unreliable
Some organizations use the cost of living for setting salaries. However, it falls short of achieving fairness. Here are a few reasons why relying on the cost of living can be misleading:
Outdated and flawed. While traditionally used to adjust salaries, the cost of living is heavily influenced by individual circumstances, making it an unreliable measure. Factors like civil status, number of dependents, and spending habits can significantly affect an individual’s cost of living. Basing salaries solely on the cost of living doesn’t reflect the actual value of the job in the labor market.
Location bias. Using the cost of living creates a geographical bias. But location shouldn’t dictate a job’s worth. A highly skilled monitoring specialist in a field office might be paid significantly less than a less-experienced colleague at the country headquarters simply because of where they work.
Challenges in defining the cost of living. Defining a fair and accurate cost of living presents a challenge. Unlike a fixed measure, it varies significantly between individuals. The amount needed to live comfortably can differ greatly from person to person. Even within the same country, people can have vastly different spending habits and consumption choices, making a single standard impossible.
Unrelated to the job. The primary purpose of compensation is to pay staff in exchange for their services. But the cost of living focuses on personal circumstances unrelated to the job’s purpose. It does not dictate how much a job is worth in the labor market, so why use it to determine salaries?
A shift in perspective
Employers must remember that it is not their responsibility to maintain their staff’s lifestyle. While a competitive salary should allow staff to afford a decent standard of living, individual choices and financial situations significantly affect that equation.
Better yet, focusing on the cost of labor ensures clarity and transparency. You communicate your compensation policy and how much you’re willing to pay for roles in your target markets.
Why the cost of labor matters
Although the cost of living seems like a compassionate way to structure salaries, it doesn’t build a fair and sustainable compensation program. Here’s why focusing on the cost of labor is the better, and often the only, approach that matters:
Objectivity and transparency
Donor justification. For nonprofits relying on donor funding, the cost of labor provides precise, objective data for justifying salaries. Donors expect the responsible use of funds, and using the cost of labor as a benchmark shows that salaries are based on labor market value. The cost of living offers little justification in this scenario.
Reaching the right talent. Attracting the right talent with the right skills in the private sector requires understanding market value. By understanding salary trends and compensation practices for roles and grade levels in their target markets, organizations can craft competitive offers.
Sustainability
Clear and job-based: The cost of labor focuses on the value of the job itself. It considers market data for positions of equivalent worth, ensuring fairness and clarity in attracting and retaining the talent that you need.
Informed decisions and budget alignment. By understanding your compensation costs through the lens of the cost of labor, you can make better-informed decisions that align with your budget and brand identity within the labor market. Focusing on the cost of labor also allows for more strategic adjustments during economic downturns or periods of social unrest, fostering long-term sustainability.
In conclusion
We recommend setting salaries using the cost of labor—how much other employers in the labor market pay for the same or similar roles. This approach involves setting pay based on labor market survey data grounded on simple and clear job evaluation, which moves quite independently of the cost of living and is impacted by supply and demand in the labor market.
Get in touch with Birches Group
Basing salaries on the cost of labor is a crucial feature of a well-designed compensation framework, but it’s only the beginning. Another feature is credible market data, such as salary surveys, to help assess your position in the market.
Stay on top of labor market trends. Access our comprehensive salary surveys and use our data to make informed compensation decisions. We publish updated labor market data three times a year in over 150 countries, making sure you have the most current information for your talent management needs.
Contact Birches Group today to learn about our salary surveys and how they can benefit your organization.
Carla is a part-time copywriter on our marketing team in Manila. Before shifting to freelance writing in 2020, she worked as a marketing and communications specialist at the offices of EY and Grant Thornton. She has written about HR and career development for Kalibrr.
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