Cost of Living Increases: The Dinosaurs of Pay Practices?

A recent WorldatWork study reported that only 11% of US employers say that they award cost-of-living adjustments (COLAs) to employees.  A COLA refers to an across-the-board wage increase to bring pay in line with increases in the cost of living to maintain real purchasing power.

It is not easy to see why such a low percentage of employers subscribe to this practice.  Under the COLA approach, poorly performing employees receive the same increase as the best performing ones—not an attractive practice for many firms. Automatic COLAs may not always make financial sense in a particular year, especially if the company’s performance has been less than stellar.  COLAs can also create a sense of entitlement among employees, making them believe (inaccurately) that the organization has a responsibility to maintain employee purchasing power.

Not even the strongest supporters of COLAs would justify such increases in all cases.  Why?  Because sometimes (though rarely), the cost of living goes down.  For example, between 2008 and 2009, the CPI-U (cost of living for urban locations) decreased by .4%.  I don’t recall anyone clamoring to have his or her salary reduced by the same amount in order to keep it in line with the cost of living for that year.

It makes much more sense, in my view, to provide salary increases based on performance.  This will accomplish a number of things.  It will give you more flexibility depending on the organization’s performance.  In good years, increases can go up.  In bad years, they may have to come down.  Employees should see the linkage between their rewards and company performance.

It also gives you a better chance to provide meaningful increases to your best performers, the people that you have to keep.  From a business standpoint, doesn’t that make sense?

I will be the first to admit that pay for performance plans can be challenging to implement.  If not done well, they can backfire.  But I have also worked on enough of these initiatives to know that if designed correctly they can also be a powerful motivator and a sound business practice.

Your thoughts?

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