Dollars and Sense: Cost of Living or Competitive Wage Increase?

The difference is really a question of philosophy. Unlike a lot of philosophy I’ve read over the years, this one is simple logic.

First, the basics:

Cost of living reflects the price of goods and services required to maintain an “average” level or standard of living. When companies provide a Cost of Living Adjustment (COLA), it is based on inflation from the Consumer Price Index (CPI). (Didn’t take a class in macroeconomics? No problem - check out the BLS for enough of a primer on the CPI to make you dangerous.)

Cost of labor reflects the wages paid to workers. (Doesn’t this sound much simpler? And don’t people want to be paid similarly to their peers?) In part, cost of living is cost of lifestyle. Clearly, there’s lots of room for variation. Competitive wages, however, are tied to the cost of labor – which logically will include relevant cost of living considerations based on the labor market.

I’m no fan of the cost of living increase as a pay strategy. Here’s why:

1. The CPI, and hence, the cost of living, fluctuates. But you don’t see companies taking money away from employees when it drops. I’m not advocating that they should, but adjustments to pay based solely on cost of living are expensive over time. Worst case scenario is that wages are frozen, and that does little to retain the people you can’t afford to lose.


2. Providing across-the-board COL increases to all job holders devalues the market and internal worth of various jobs, individual contributions and performance. It can also exacerbate pay inequities. That’s why you’re annoyed when you’ve worked your back end off all year only to receive the same increase as your slacker co-worker three cubes over.


3. Coupling COL adjustments with longevity pay inevitably results in wages that far exceed the market and ultimately becomes cost prohibitive. But the employees love them – and so they rarely leave! (That’s not always a good thing.)

Sure, we can easily compute the future value of a bad compensation decision in dollars and cents. It’s a little more difficult to quantify the loss of key employees who aren’t paid competitively or the decline in productivity due to lack of employee engagement. Those costs, I’m afraid, are very real.

Authored by Sandy Turba