London; one of the most expensive places to live in the world.
So… this evening I was going to write about the behaviors that I look for when evaluating talent (and why said behaviors are valued added in any job), but this afternoon I had a great conversation about cost of living adjustments with a friend…
…And so instead today I want to share my take on best practice as it concerns the COLA. 1
The Cost of Living Adjustment (also known as the COLA in HR/Comp speak) is an adjustment that a company will sometimes make to an employee’s wage (typically base salary) to reflect rising (or declining) purchasing power as a product of changes in living cost.
Some of the most expensive cities in the U.S.
Typically, a cost of living adjustment is administered when an employee moves from one labor market to another and the living cost are significantly higher in one market than the other (think Tulsa, Oklahoma to New York, New York City). The thinking goes that if one goes from having to pay, say, $500 dollars a month in apartment rents to $1,500 2 that one’s living standard will considerably decline if he/she doesn’t receive a COLA to help mitigate the loss of purchasing power.
When moving to a new market every little bit helps.
A COLA can also decline – typically if one moves to a higher cost of living area on behalf of their company and then later moves to a cheaper location. 3
There are very few topics that I have a particularly strong opinion on (I’ve been wrong far too often and about far too many things over the years to take a dogmatic stance on many subjects)… and particularly in the world of compensation – a world where outliers and exceptions are so common in the marketplace that they may as well not even be referred to as such – applying a rule too broadly is typically a sign that you’re not considering the issue carefully enough.
That said, I really believe in using COLAs anytime a company moves an employee to a location where the increase to their living costs outpaces whatever salary increase (if any) he or she receives to take on the new role. I don’t believe this viewpoint is really out of line with general compensation best practice, either (although some would argue that the increase in cost of living must pass a certain threshold before a COLA is administered as part of a package).
Where I think I differ in the application of COLAs with many compensation professionals, however, is on what to do with them once (if) the employee who received said COLA moves to a lower cost of living area where the COLA is no longer warranted.
I think that a COLA should usually constitute a permanent change in the pay package – even if the employee moves to a lower cost of living area later – and here’s why:
This employee looks like he lost his COLA.
1. Employees view the loss of a COLA as a decrease in salary (even if their purchasing power remains the same once they move to the cheaper market). Moving an employee into a new role where they feel cheated because they’ve “lost” wages they grew accustomed to is akin to low-balling a candidate on salary during the job offer process. Even if the candidate accepts a below market offer, once said candidate gets into the organization and finds he/she is underpaid he/she can become bitter (which is one of the last things an employer should want its new hire to be).
2. If an employee receives a COLA to move to a more expensive labor market he/she will often turn down future opportunities (in less expensive labor markets) if he/she isn’t allowed to keep the COLA with the move.
3. Employees give up a lot to move to a new location:
A. Close relationships with friends and family.
B. Home Equity: As a product of necessity someone that relocates (especially if they do so often for a company) is a renter and not buyer. In addition to the lost value of income that goes into paying for a rental property as opposed to a home, renters are also more susceptible to changes in the cost of living since rent increases annually (while a home owner doesn’t experience this annual increase).
C. Their expenses temporarily rise (sometimes sharply) in a new market while they find deals and learn how to live economically in the new market. Relocation costs will absorb some of this cost but not all of it.
D. Employees that frequently move give up the sense of stability and comfort that comes with living in one location (and establishing a foundation) over time.
To be sure, employees often gain considerably from the transaction as well (often in the form of new skills and career development, raises, and life experiences). Yet the employer also benefits from these things by being able to move an existing employee (who understands the company culture and steps into the new role with much company-specific knowledge) into the open job as opposed to having to hire externally (which can get very expensive). Saving on the additional headcount and benefiting from the (likely) shorter training period gained from having an internal hire step into a new role are both huge pluses for a company.
…So I’ll say that a company letting its employee keep their COLA if the employee is later re-located to a lower cost of living area isn’t the worst idea in the world. There are certainly some challenges with this model (mainly salary bloat once employees realize they can kind of “game” the system by taking a position in a higher COLA area only to later move back home with increased purchasing power), but if a company has competitive pay ranges that reflect the market this shouldn’t be an issue.
Once an employee is at the pay ceiling there is nowhere else to go – this prevents the system from really being “gamed”.
A company can always red circle an employee at or above the top of the pay range, and as long as said company’s pay ranges are in line with their market philosophy, transparent to employees, and the policy is consistently applied employees will understand it. There’s nothing wrong with having the top performers at the top of their pay range (as I’ve said before they should be there anyway), and employees who a company relocates into roles in new labor markets often qualify as top performers or high potentials.
Ultimately, it isn’t an employers responsibility to maintain its employees living standard, per se. But with that said, as a retention tool I think paying based on cost of living (as opposed to cost of labor) is smart since – if upon moving into a new role – an employee finds they can’t pay for the goods and services they did in their previous location there is a strong incentive to look externally to regain that purchasing power.
This has again gotten a bit on the long side, so I’m going to close here. I’ll certainly look revisit COLAs at a later date, however, as I think this is a rich topic with lots of nuances worth discussing.
Share your thoughts below.
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