Expect Pay Merit Increases to Continue to Rise in 2023
Workspan Daily
October 25, 2022
Key Takeaways

  • On the rise. Salary budgets and wages are increasing higher than ever, according to research from WorldatWork, Willis Towers Watson and Mercer. 
  • Major impact. Labor shortages, cost of labor and business performance were the top three factors organizations said were impacting their 2023 merit budgets. 
  • Bonuses and other short-term incentives are doing well. As most organizations delivered strong financial results, nearly half of them reported that short-term incentives were paid out above target for all employees. 
  • Challenging future. A 6% merit budget will not be out of line as employers face a tough compensation year. Inflation and a declining economy will continue to play a part. 

If the past 10 months have revealed anything about compensation, it is that salary budgets will continue to increase. 

WorldatWork’s “2022-23 Salary Budget Survey” revealed that salary increase budgets reached their highest level in 20 years in the United States, rising to an average of 4.1% in 2022 with a 3.8% median. 

When it came to pay merit increases, participating organizations reported awarding at least some base salary increases (e.g. general increase/COLA, merit increase) to 88% of employees in 2022. 

Willis Towers Watson (WTW) research also conferred 2022 salary increase budgets were higher than ever. WTW’s “July 2022 Salary Budget Planning Survey” results showed that 96% of companies globally increased salaries (compared to 63% in 2020), and overall budgets have increased significantly over prior years. 

Could inflation be the reason? 

Not necessarily, according to experts at Mercer

“We see in our research and work with clients that labor shortages have been the key driver of heightened merit increases, not inflation,” said Lauren Mason, senior principal, career at Mercer.   

And as employers set their 2023 preliminary budgets, Mason told Workspan Daily labor shortages, cost of labor and business performance were the top three factors organizations said were impacting their 2023 merit budgets. Only 30% of employers said inflation was having a high impact on their 2023 salary budgets. 

But as wages rise, what are compensation professionals seeing as the true cause? 

New Trends 

Looking back at the new trends that affected pay merit increases and pay for performance this year, Mason said it wasn’t about what happened inside the annual merit process but what was happening outside of it.  

“Employers made extensive out-of-cycle compensation increases during 2021 and 2022 in response to the labor market. While this was prevalent at all levels, it was most extensive for hourly workers,” she said. “Employers reported their total 2022 base pay increase budgets at 3.8%, but our data showed a 6.7% increase in base pay for hourly employees staying in the same job at the same organization from 2021 to 2022.

“The labor shortages forced employers into reactive compensation changes in 2021 and 2022, but it will be important for employers to be more proactive and strategic about compensation increases in 2023, particularly in light of pay equity concerns and a declining economy.”

Sal DiFonzo, managing director, compensation and rewards consulting at Gallagher, and a member of WorldatWork’s Compensation Advisory Council, said the most salient trend he saw this year was the increase in merit budgets from 3% to now between 4-5%.  

“This breaks a long historic streak of steady 3% budgets for years,” he said. “Concerning pay for performance, I did not see as many incentive plans ‘breaking’ like they did during COVID, when performance missed targets. High performers continued to earn meaningful bonuses on the incentive side, but on the merit budget side, high performers likely earned more than the merit budget but not enough to exceed inflation this year.”

Although DiFonzo believed inflation did cause merit budgets to increase, the tight labor market also played a significant part. 

“[It] is a key input into inflation, so these factors are closely related,” he said. “The increase in lower-skilled worker wages caused compression into higher-skilled wage amounts.” 

Bonuses and other short-term incentives also did well in 2022. 

“Companies and organizations appeared to perform well in the emerging post-COVID environment, and this performance resulted in a good bonus payout for most workers,” DiFonzo said. “Plans seem to return to normal functionality, and there was less of a need to provide subsidized payouts, lowered goals and thresholds.” 

Mason said as most organizations delivered strong financial results, nearly half of them reported that short-term incentives were paid out above target for all employees.  

In addition, Mason said over 80% of organizations in Mercer’s “2022 US Compensation Planning Survey (August edition)” reported that they were maintaining their one-time annual compensation cycle.  

“However, we saw significant off-cycle activity during 2022,” she said. “These were not planned or budgeted increases, but rather ad-hoc compensation changes driven by retention concerns, counteroffers, internal equity fast-moving market conditions or other competitive pressures.” 

DiFonzo said although some of his clients allocated an additional general inflationary increase in addition to a merit increase, he did not see a two-cycle merit increase. 

“Many of our clients struggle with performance management and are not happy with their current systems,” he said. “I absolutely believe that managers were forcing higher merit increases, regardless of performance, in order to keep up with wage inflation and to keep talent.” 

And according to Mason, today’s compensation strategies largely reward employees who switch jobs, not those who stay. However, Mercer’s research shows that tenure is the single largest human capital driver of both operational and financial performance within an organization, she said. 

“Employers should examine compensation growth for their long-tenured high-performing employees and ensure they’re competitive with the external market. Our clients are doing pay equity and opportunity equity analyses to make sure the merit and promotion process doesn’t disadvantage tenured employees.” 

2023 and Beyond 

Whether it is inflation or the tight labor market driving the increase in wages, employers will have to adjust their strategies accordingly in the coming year. 

DiFonzo recommends setting merit budgets between 4-5%, with a minimum of 4%. If organizations can afford it or are in an industry with an extremely tight labor pool (hospitality, restaurants, health care attendants), a 6% budget would not be out of line, he said.  

“One of my clients, a multi-location behavior healthcare center in Southern California, had great success in calming attrition after giving a 6% across-the-board increase, followed by 6% merit increases,” he shared. 

On the other hand, Mason admits the 2023 compensation cycles are going to be tough.  

“Inflation has placed significant financial stress on employees, and compensation satisfaction is declining, but employers are facing a declining economy,” she said. “It’s unlikely that compensation increases will live up to employees’ expectations. Employers need to focus on differentiated strategies that reward high-performing loyal employees and address fast-moving sectors with high turnover, such as hourly workforces.  

“The 2022 compensation increases were chaotic and frenzied. 2023 is the time to be strategic and deliberate with compensation investments.” 

Editor’s Note: Additional Content 

For more information and resources related to this article see the pages below, which offer quick access to all WorldatWork content on these topics:

Related WorldatWork Resources
Spotify to Lay Off 17% of Workforce
How to Mitigate Bias in the Performance Review Process
Clear Communication Around Equity Shares Benefits Companies and Employees Alike
Related WorldatWork Courses
Sales Compensation: Foundation and Core Principles
Advanced Excel Skills for Compensation Professionals
Sales Compensation: Advanced Implementation and Program Management