Three Ways to Approach 2023 Salary Increases Amidst Rising Volatility

Economic volatility, geopolitical tensions and a host of other challenges are driving business performance down, while talent pressures remain sky high.

Many companies awarded more aggressive salary increases in early 2022 (read more in our article “With Inflation on the Rise, the Latest Salary Data Reflects Higher Than Normal Increases”) as they entered post-pandemic recovery and wanted to compensate and retain key talent. Looking ahead to 2023 salary increases, the business environment has weakened. Continued uncertainty caused by inflation, an anticipated recession and still-strong labor markets require a different approach to salary decision-making for the year ahead.

“In speaking to my clients this year, I expect widely divergent salary increase practices between firms as they navigate a volatile and uncertain environment,” says Adam Barnett, partner, Human Capital Solutions, Aon. “While there is always a combination of external and internal drivers at play when setting salary budgets, rising economic uncertainty and increased market fragmentation are making salary increase planning especially difficult this year.”

Strong performing companies favor larger salary increase budgets and tend to provide more competitive total compensation to avoid undesirable employee turnover. Some may also try to incorporate the impact of inflation into pay.

Companies that focus on other elements of total rewards besides salary, or are facing tougher business conditions, or provided above average salary increases in 2022, may be looking towards smaller than average increases for 2023.

Consider variety of data to inform salary increase decisions

Companies have historically relied heavily on external salary surveys to understand the market and their competitors’ practices. To guide their thinking in the year ahead, however, many HR and compensation professionals tell us they plan to gather additional perspectives.

“Given today’s uncertainty, survey respondents may lack conviction about their survey submissions and, in turn, the surveys’ actual results,” Barnett explains. “Actual salary actions, occurring early in 2023, could vary materially from planned budgets.”

Nonetheless, several regions are planning for higher salary increase budgets in 2023, based on the latest figures from the second edition of Aon’s 2022 Salary Increase and Turnover Study.

In the United States, median salary increase budgets overall are forecasted across industries at 4.6 percent, a modest increase from 4.5 percent paid out in 2022 but much higher than the U.S.’ recent historical average of around 3 percent. In the United Kingdom and Singapore, budgets are forecasted to be 4.5 percent compared to 4 percent last year. In Germany and Australia, budgets are forecasted at 4 percent in 2023 vs. 3.5 percent in 2022.

"The data reflects the continued tight labor market across many parts of the world,” says Ephraim Edelman, partner, Human Capital Solutions, Aon.

However, external data is one part of the story for developing a salary increase strategy in a volatile and uncertain environment. The key is to contextualize salary increase planning surveys with historical analysis and the unique circumstances of your own industry and organization. “Take in different data points — both external and internal — and decide what makes sense for your organization,” says Edelman.

Define salary increases by various factors

While it is critical for businesses to define and adapt pay increases for factors such as different worker types and nature of work, organizations must stay agile as they rethink their pay principles. By making changes in a phased manner to optimize pay effectiveness, businesses can shape their strategies towards long-term drivers of pay and performance.

“Alongside adopting diverse pay frameworks for different working models, companies should define their 2023 salary increases in the context of the competitiveness of their current salary levels and employee value proposition,” explains Rahul Chawla, partner, Human Capital Solutions, Aon. “For instance, many companies are considering a skill-based compensation program as a way to ensure they are maintaining and building future skills in their organization.”

When moving to a skills-based compensation model, employers will need to identify future skills critical to business success, ascertain the value of those skills and reward them appropriately (read more in our article “Closing the Future Skills Gap to Drive Business Success”). Salary increases can be distributed to those who broaden or deepen their current skillset and/or acquire new skills outside of their current scope of work. This will ensure not only personal development for employees but also allow companies to adapt to changes and stay current with the rapid pace of technology.

Identify a targeted approach towards your budget

Aon’s workforce data shows a significant difference in the degree to which employers differentiate pay (larger increases vs. smaller increases) and how that approach varied by salary bands. The philosophy around pay differentiation is critical to make sure that salaries address level of promotion, performance, impact, and potential among their employees. Consider some of the following scenarios:

• What size salary increase is appropriate and affordable for employees who are “about average” relative to performance and/or criticality (i.e., in the middle 20 percent of the performance and/or criticality distribution at any given pay level)? For example, based on a firm’s unique circumstances, that may equate to 6 percent for individuals earning US$100,000 to US$150,000 per year.

• To what degree do you want to differentiate pay for employees who have lower or higher performance, impact, and/or potential than an “average employee”? Continuing with the above example, if an average employee at a given pay band receives a 6 percent increase, should a bottom quintile employee at that pay band receive a 2 percent increase (i.e., 33% of the average)?

• To what degree should this philosophy – this dispersion and/or differentiation of pay increases – vary for employees with lower or higher salaries?

“Using this type of salary matrix with your actual staffing profile can help model out a salary increase pool that is anchored by your company’s compensation philosophy and employee value proposition,” Edelman explains.

Incorporating Inflation into the Salary Increase Process

Looking Ahead to 2023

When competing on salary, there is little margin for error in not getting that number right from a competitive point of view. Leading companies know that embracing a holistic view of total rewards and employee wellbeing is the most sustainable and successful strategy for keeping workers engaged.

Employers must take a strategic approach to optimizing their people spend. Some tips include:

1. Create a model or philosophy based on your business need

2. Carefully benchmark your current pay competitiveness, ensuring you have a sound basis for upcoming pay decisions

3. Introduce an internal equity lens

Ultimately, setting salaries in a highly inflationary and volatile environment will be a delicate balancing act.

“A tight labor market will continue to challenge employers in the near term,” says Brooke Green, head of Human Capital Solutions, North America, Aon. “As turnover increases, companies must review their total rewards strategies and look at resilience, agility, wellbeing and purpose to retain and attract top talent.”

To help your organization plan for the upcoming compensation and performance cycle, please read Aon’s 2022 Salary Increase and Turnover Study. For more information on developing a compelling total rewards program and building workforce resilience, please visit our latest insights.