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The Connection Between Inflation and Employee Engagement

The Connection Between Inflation, Compensation, and...

Inflation continues to rise at the fastest rate in 40 years – the consumer price index (CPI) increased by 9.1% between June 2021 and June 2022. Organizational leaders may wonder how this affects employee engagement and retention. There’s a direct link, as well as steps leaders can take to address engagement issues resulting from this.

Understanding Employee Engagement: Recent Context

Employee engagement within an organization is affected by both internal and external factors. Internal factors can include:

  • The availability of resources
  • The efficiency of systems and processes
  • Manager effectiveness
  • Growth and development opportunities
  • Organizational culture

In 2019, an important external factor was record low unemployment. In addition, consumer sentiment was very high, and the economy was booming, which caused organizations to invest heavily in efforts to retain key talent. Throughout 2020 and early 2021, COVID-19 and organizations’ response to the pandemic boosted employee engagement through increased organizational commitment. As a result, employees felt supported and decided to stay with their employers. 

Inflation and Employee Engagement

As of July 2022, inflation is rising at the fastest pace in 40 years. In addition, consumer sentiment is the lowest ever recorded since the University of Michigan began recording it in 1952, down a whopping 44% from a year ago. So what does this mean for employee engagement, and how can organizations best respond?

First, inflation and rising costs have changed the way compensation shows up in employee surveys. Before 2022, many organizations saw zero correlation between how employees responded to the statement, “I’m paid fairly for my contribution to the company,” and their actual compensation. Instead, people who disagreed that they were paid fairly often voiced, “I’m not paid enough to put up with [insert workplace challenge].” If an organization increased compensation but failed to address underlying issues such as availability of resources, work/life balance, or a perceived lack of growth opportunities, then due to hedonic adaptation, employees would experience a temporary boost from the increased pay before adjusting to the new pay level and reverting to the prior state of dissatisfaction only months later.

Pay as a Critical Differentiator

We see pay more often as a critical differentiator between highly engaged and less engaged employees in 2022. Dissatisfaction with compensation is also greater among those at the lower end of the pay scale as increasingly expensive necessities such as gas, housing, and food significantly and immediately impact these employees’ quality of life. Even where minimum wages have increased, buying power decreases as the dollar continues to lose value faster than those wages have risen.

The Loyalty Tax

Inflation is pouring gasoline on the “Great Resignation,” with employees feeling increased financial pressure to seek new employment. The “loyalty tax” is the idea that employees who do not change companies every few years earn significantly less income over the course of their careers. This reality was true in the past, but new research shows that the loyalty tax is going into overdrive. On average, organizations pay new hires 7% more to do the same jobs as people currently or previously in the position. This pay disparity can undermine trust when compensation adjustments fail to keep up with inflation. Incumbent employees see that companies are willing and able to budget for generous signing bonuses and higher salaries to bring in new employees, but will they make the necessary investments to support and retain their existing employees? If not, companies risk losing significant experience and relevant organizational knowledge, not to mention the additional costs associated with recruiting and onboarding new employees.

Some retention strategies have fostered toxic workplace cultures. For example, when an employee receives another job offer and gives notice to their manager, there can be a temptation to counter and offer higher compensation to avoid regrettable voluntary attrition. However, if word gets out, it can lead employees to believe that threatening to leave is the only way to obtain a significant compensation adjustment, undermining trust between employees and the organization. 

Trust Matters

At the core of relational trust is the question “Do you understand me and want the best for me?” When employees believe their organization understands them and wants the best for them, it builds emotional equity and commitment while significantly increasing employee engagement. Engagement requires the anticipation of success, which is difficult when employees feel misunderstood or undervalued. 

In an era of significant inflation, relational trust entails rethinking compensation strategies. Organizations cannot disassociate the relationship between the value an employee provides and how they are compensated. Now more than ever, organizations have the opportunity to identify and eliminate barriers to efficiency and effectiveness. Consider the 80/20 rule – the idea that 80% of the created value comes from 20% of the activity intended to create that value. What low-value activities do employees engage with regularly that they could eliminate in favor of higher-impact work that would allow the organization to adjust compensation accordingly? 

What Organizations Can Do

Compensation policies represent an opportunity to reinforce organizational values such as integrity and care for people. For example, some organizations will adjust current employees’ compensation if a new hire is brought in at a higher pay rate to maintain equity and avoid creating pay gaps. Having a policy around negotiating raises for employees who give notice can also help prevent managers from being caught off guard and reacting in the moment instead of responding to the situation in a measured and intentional way. Shortening cycles between adjustments or bonuses can also help relieve pressure on employees who may feel worse off financially than they were a year ago. 

The Basics Still Apply

Help employees understand how their compensation is determined, and performance is measured, ensuring a clear link between the two. Review external compensation data to ensure pay is in line with market averages and, during a time of inflation, ensure the benchmark data is current to avoid blindsides linked to outdated figures. Use pay bands to create and maintain compensation equity within roles.  

Empathy Is Key

Asking, listening, and responding to employee needs is critical during change, especially when the changes affect employees’ financial wellbeing. Engagement is about the anticipation of success. Suppose leaders intentionally seek opportunities to create margin so compensation can keep pace with increasing costs that affect their employees. In that case, these efforts can go a long way to building confidence and trust that the organization understands its workforce and wants the best for them.

During a Time of Economic Uncertainty, Perceptyx Can Help You See the Way Forward

Establishing the proper context for conversations about inflation matters, as does having the correct data at your fingertips. As an experienced listening partner, Perceptyx can help your organization conduct all the meaningful conversations needed to fully and comprehensively understand employee engagement. To learn more about how we can help, schedule a meeting with a team member.

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