Facing the tightest labor market in decades, many CFOs plan to retain employees this year with pay raises exceeding 3%, but this may still not be enough.

Data from The Conference Board shows that with inflation far outpacing salary increases, worker quit rates are at multi-year highs, and nearly a third of job switchers received pay raises of more than 30% from new employers.

Labor market experts point out that CFOs are letting wage increases lag behind inflation because they expect that as the COVID-19 pandemic subsides, people who previously left the labor force will return to work, job openings will fall from near-record levels, and wage pressures will ease.

However, experts warn that CFOs should not expect the wage push pressures and the war for talent to end quickly. The U.S. population is aging, shrinking the labor pool; additionally, many people retired early during the pandemic, causing the labor force participation rate last month to be only 62.3%, which may not recover to pre-pandemic levels.

Experts say that rather than waiting for labor supply to recover and ease wage pressures, CFOs should take proactive measures to attract and retain talent and win the war for talent.

"We assume everything is a labor market problem, not a people management problem; a public policy problem, not an employer problem—but that's not the case," said Peter Cappelli, director of the Center for Human Resources at the Wharton School of the University of Pennsylvania. "Management can do a lot; the entire field of people management has been neglected by us."

Experts suggest that while raising wages, CFOs should consider developing incentive plans that link at least part of the pay increase to productivity gains; they should also identify which benefits are most valued by different employee groups, as well as those benefit programs that are lowest in cost and highest in return.

CFOs should also fund programs aimed at maintaining employee mental health and fostering a sense of community, including training supervisors on how to build strong connections with their direct reports. Experts say these measures help buffer the impact of inflation on employees, thereby stabilizing the workforce.

The 'price-wage' spiral

Moody's notes that rising consumer goods costs may have triggered a 'price-wage' spiral, pushing up compensation costs.

The U.S. Labor Department reported Thursday that the consumer price index (CPI) rose 7.9% year-over-year last month, the fastest pace in 40 years; the producer price index (PPI), which measures supplier charges, surged 9.7% year-over-year in January.

The Conference Board said: "A wage-price spiral—where price increases and wage increases feed on each other, causing both to accelerate—may already be emerging in some industries or regions."

The National Federation of Independent Business (NFIB) said Tuesday that small businesses see inflation as their biggest challenge, with the proportion of firms raising prices last month hitting a 48-year high.

As inflation accelerates, wage growth is slowing. Labor Department data Thursday showed that average weekly wages, adjusted for inflation, fell 2.3% year-over-year last month.

The Conference Board says nearly two-thirds (62%) of workers are concerned that inflation will further erode their incomes in the coming months.

Labor Department data Wednesday showed that the quit rate (the proportion of quits to total employment) has fluctuated between 2.8% and 3% since June, the highest level since 2000.

Workers are switching jobs in droves; The Conference Board says 29% of job switchers received at least a 30% pay increase from new employers. The Pew Research Center said Wednesday that among workers who left jobs last year, nearly two-thirds (63%) attributed their departure to being underpaid.

"This is an extremely competitive market, unlike anything I've seen before," said Shawn Cole, co-founder of executive search firm Cowen Partners. "There is a huge pent-up demand for talent."

A Payscale survey of 5,578 respondents involved in compensation decisions (from companies in the U.S., Canada, and other countries) found that two-fifths (44%) of companies plan to raise pay by more than 3% this year to retain employees.

Some surveys show companies plan pay increases of up to 5.2% this year. Even so, 85% of respondents in the Payscale survey worry that pay raises won't offset inflation.

"Employers are busy figuring out what to offer new employees and how to design pay raises to retain existing staff," said Shelly Holt, chief people officer at Payscale. "Compensation planning has never been more important; it must be done right."

The Conference Board says U.S. CEOs rank the tight labor market as the top external pressure point for 2022. "As bargaining power shifts from employers to workers, companies should prepare for higher wage and benefit costs and higher employee turnover in 2022."

Workplace temptations

Experts say companies are offering a range of temptations to attract and retain employees, including signing bonuses, flexible work arrangements, and higher education subsidies.

"You have to prioritize the things that are relevant to your employee population," said Catherine Hartmann, North America rewards practice leader at Willis Towers Watson, in an interview.

She suggests CFOs work with HR to identify benefits that are most attractive to different employee groups. For example, a $2,000 bonus for outstanding work might be more appealing to a 25-year-old employee than increasing the 401(k) match rate.

"It would be wise for CFOs to put a little pressure on HR people and ask: 'What kinds of things retain people? Which are expensive? Which are cheap and easy?'" said Wharton professor Cappelli.

He notes that signing bonuses and mental health referral services are low-cost and well-received compared to many other benefits. The same goes for tuition reimbursement programs—"they're very cheap because almost no one uses them."

Cappelli says CFOs can measure the cost of employee turnover by collecting data, thereby determining the return on retention spending. "The idea is simple, but most employers simply don't know the answer, which is embarrassing—it's shocking."

Although many CFOs measure the cost per hire, only a quarter of companies make an effort to track the quality of new hires, he said in the interview. "It's all CFO-driven," he said. "They don't ask these questions, sometimes because they don't know what to ask."

Culture is key

Jesse Morris, CFO of Main Street Capital, says that since the start of the pandemic, many of the more than 150 companies in its portfolio have attracted and retained employees by raising wages, developing incentive plans, emphasizing culture, and focusing on employee development.

Companies invested in by Main Street Capital have annual revenues between $10 million and $150 million, spanning industries such as construction, manufacturing, energy, and telecommunications.

Morris said in an interview that many companies accelerated streamlining plans after the outbreak of the pandemic. Higher efficiency helped them adapt to the tight labor market and the surge in demand from customers unable to obtain goods from other producers due to supply chain bottlenecks.

Some companies have linked pay raises to productivity improvements. They have also improved efficiency by investing in capital equipment, redesigning assembly processes, and emphasizing kanban-style inventory control.

Additionally, "many companies are investing a lot of time and effort in creating the right work environment," Morris said. "Compensation must be competitive, but in the end, if the work environment isn't right, you'll still lose talent—you have to provide people with challenges and opportunities to grow."

Experts point out that CFOs should not overlook the recruiting and retention benefits of showing care for employees' emotional well-being both inside and outside the workplace.

"Being treated well, being respected, and knowing that you'll receive sympathy from your employer when tragedy strikes in life—that sense of loyalty is profound," Hartmann said. "I've heard many people say: 'I was thinking of leaving a company, but then my father passed away, and the way the company treated me taught me about the people I work with and the place I want to be part of.'"

Cappelli says CFOs can improve recruiting and retention at low cost by training supervisors to promote employee mental health.

"The most important factor in retaining employees is social connection," he said. "In terms of retention, the cheapest investment you can possibly make is upgrading the skills of supervisors—that could bring the biggest returns."

He suggests supervisors hold 30-minute calls with their direct reports each week. "The first thing you should ask is: 'How are you doing?'" he said, noting that sensitivity requires sincerity. "The problem is trying to fake it."