Did anyone hear the news this summer about yet another Silicon Valley tech giant announcing an extension of work-from-home arrangements for employees for at least another year? It’s not really surprising in the age of COVID-19.
But how about the news that multiple companies are publicly discussing pay cuts for employees working remotely who move away from where their employer is located to someplace with a lower cost of living? If you heard about it, you likely reacted the same way many of these employees did — with a jaw-dropping “WHAT?”
For tech companies in costly San Francisco, the rationale behind the thinking is this: If employees move out of the Bay Area as a result of (now) being able to work anywhere, then their compensation should be adjusted based on the new location. After all, these employees are no longer working in the high-cost labor market of Silicon Valley, right?
Arguably, the benefits of this approach include expanding the talent pool to candidates who wouldn’t consider moving to big cities no matter how prestigious the company. The move would also increase companies’ opportunities to improve retention and diversity while also spreading economic opportunity into more geographies.
To the average reader, paying people based on where they live might sound logical, given the proliferation of remote work options. This approach, however, should make compensation and HR professionals cringe because it fails to consider the danger of grounding compensation philosophy and programs in individual employees rather than in jobs. Here’s why:
- Compensation strategy and philosophy typically addresses how organizations will use rewards to attract and retain employees, but pay is grounded in jobs, not people. For example, a company may state: “We aspire to attract and retain the best and brightest employees by paying competitively in all the markets in which we compete for talent.” This simple statement is about how to hire and keep employees, but to make it real, it’s about setting competitive pay levels for jobs and then applying those job-driven pay levels to specific employees.
- Organizations must define their competitive labor markets in order to turn a competitive pay philosophy into reality. Depending on salary levels, competitive compensation is driven by several factors such as industry-specific, role-specific or geography-specific drivers. But most importantly, the targeted competitive labor market for any organization should clarify from whom/where it gets people and to whom/where it loses people.
- For higher salary levels, pay is primarily driven by industry and company revenue size. This explains why a CEO search tends to be national or even global rather than local. However, as salary levels decrease, geography often drives the setting of competitive pay rates enough to warrant building them into not only a compensation strategy and philosophy but also adding “geographic salary differentials” into the design and delivery of pay programs. These differentials are rarely about where potential or current employees live, but more focused on where the jobs are located (i.e., where they work).
And, so here’s the rub that 2020 has presented – what if where employees work is no longer relevant because they can work anywhere? Working remotely has meant that jobs sit wherever an employee is physically located versus where the organization is physically located. What does that mean for how we would define an organization’s competitive labor market? Is geography still a relevant factor in setting an organization’s competitive pay rates?
Prior to the COVID-19 pandemic, the common expectation was that most employees would work from their employer’s physical location. As such, pay structures were (and still are) based on a “Cost of Labor” economic principle. This principle is often confused with “Cost of Living,” but they are two very different concepts and are at the heart of determining how best to manage pay in a remote working world.
- Cost of Living (“COLiv”) represents a market basket of goods within a given geography, with the highest expense being housing. When looking at base salaries within different geographies, the COLiv indicator says, “This is what my $X will buy me in Chicago versus New York.” Most employees know this indicator intuitively and will often raise it in trying to make the case for higher wages if an organization is in a high COLiv location.
- Cost of Labor (“COLab”) represents the supply and demand of labor within a given geography, or the going rate for labor in that location. When looking at base salaries within different geographies, the COLab indicator says, “As a company, we have to pay $X in Chicago versus $Y in New York in order to effectively attract and retain labor in those markets.” Employees don’t have much visibility into the COLab metric, but it is very important for employers that operate in multiple locations.
In response to the ongoing health crisis, working remotely has become standard for many industries, with notable exceptions for essential workers in retail, health care and manufacturing. This new normal shouldn’t change the fundamental practice of using jobs — rather than people — to define pay structures and make effective and fair pay decisions.
In fact, prior to the pandemic, employees who worked in high cost-of-labor locations could choose to commute from low cost-of-living locations, thereby stretching their incomes to even higher levels of buying power. And, no one talked about changing their salary because they chose a two-hour commute over the convenience of living close to the office.
Take Beacon, New York as an example. Located in the Hudson Valley, Beacon is one hour and 21 minutes by car or one hour and 39 minutes by train to Manhattan. At a $100,000 salary, the cost of living in Beacon is 9% above the U.S. national average, while in Manhattan the cost of living at that same salary level is 152% above the national average. If an employee chose to live in Beacon and commute to Manhattan, their employer would have to pay the cost of labor, which, for a job worth $100,000 nationally, would equate to $229,600 using the geographic salary differential for Manhattan.
Prior to the pandemic, the fact that an employee chose to live more than an hour away from where they work to live more reasonably would not have been a factor in how an organization would pay them. So why would it be a factor now?
Admittedly, this is a rather fine line, but an important one. Organizations can and should deploy geographic salary differentials for the same jobs that are needed in different locations for operational reasons. But all things being equal, once organizations start to pay individuals different salaries for the same job based simply on where they chose to live, it creates a slippery slope that may call pay equity/pay fairness into question.
What if, for example, some employees that chose to live in low COLab locations are also members of one or more protected classes? Is work location a defensible differentiator relative to pay equity if it is based on where individual employees live versus where jobs need to be located for the business to operate effectively?
How organizations manage this topic will continue to evolve, given the fluid nature of the remote working world. And as it does, it may mean that geographically dispersed companies will need to reexamine how working remotely fits into their existing compensation strategies and philosophies by defining their competitive labor markets for some jobs nationally or even globally while others remain tied to local market pay rates.
Here’s a practical guide for what to consider as this does evolve:
- Short term: Review how you are applying geographic differentials now. Chances are you are using many (if not all) of the sound practices described earlier. In the shortterm and assuming things continue to change, what would be gained by changing the current approach? If your organization is in major cost-cutting mode, then that purpose might be advanced by applying differentials by location in a more rigorous way, but still using jobs as the foundation for final decisions. Make sure any changes you make now are not simply reactionary to the fluid nature of the remote working world because their longer-term impact may not serve you well.
- Mid to longer term: If you have the luxury of time, consider the longer-term cost-benefit analysis of any pay changes related to remote working and how geographic salary differentials are applied. Consider how pay changes might impact your total rewards offering and overarching employment brand. Examine what it might say about you as an employer — maybe that messaging is fine for some jobs and not for others. This might also mean a more segmented approach by job or job category and could even factor in future of work considerations such as how automation and AI might impact jobs and working remotely.
- In either case, engage and educate leadership. Help them understand the full economic picture, even when lowering salaries seems like the logical way to save money in the short term. Ensure they weigh both the legal and talent risks against the benefits gained and work with them to outline the short- and longer-term impacts.
About the Author
Lori Wisper is a senior director and office line of business leader for rewards at Willis Towers Watson.