How to avoid a wage spiral in your business

Demands for higher pay are spreading. How should small business owners react?

TUC demonstration for higher wages
But how much can your employer afford?
(Image credit: © Tolga Akmen/Anadolu Agency/Getty Images)

Demands for pay rises may be the last thing small businesses feeling the squeeze want to grapple with. But just as their own costs are soaring – research from the Federation of Small Businesses shows that 82% are worried about inflation – so too are those of their staff. Employees facing a cost-of-living crisis will naturally hope that their employers will be generous.

The danger of a confrontation is very real, as the growing number of wage disputes across the public sector underlines. And while many employers may not need to think about pay rises until later in the year – if salaries work on a calendar-year basis, say – they should be prepared; inflation is forecast to remain high for the foreseeable future.

So you will need to consider carefully what your business can realistically afford to offer staff, given your forecasts for costs and revenues over the next couple of years, and what staff will be looking for.

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Inflation is expected to average around 7.5% over the course of 2022, falling to around 4.5% in 2023, so this gives you something of a base level. If you offer staff less than this, you’re effectively asking them to take a pay cut. You may feel you have no choice but to do that, but if so, you will need to manage the situation carefully.

One useful thing to do straight away is a pay-benchmarking exercise. Using resources such as Glassdoor and LinkedIn, analyse whether what you currently pay at different levels of the business is competitive compared with other employers in your sector. That at least gives you an idea of whether staff are already losing out financially. If so, below-inflation pay increases may be even more difficult to justify.

It is vital that you are as open and transparent as possible with staff about what the business is in a position to offer. If your company’s finances don’t provide the headroom to deliver the pay increases staff are hoping for, explain why.

That doesn’t have to mean opening the books for all employees to inspect, but there will be information you can share. And in smaller businesses, it can sometimes be easier to brief employees on the pressures facing the company.

Equally, employers are going to have to accept that with employment levels at an all-time high, many unhappy staff will find it easy to find new jobs elsewhere.

If you can’t finance inflation-beating pay rises, is there something more affordable you can offer instead? That could be more flexible working practices, for example, or additional holiday. Indeed, growing numbers of employers now offer flexible benefits packages, enabling staff to swap pay for perks such as help with childcare or a gym membership. These can be valuable staff-retention tools.

In fact, this is a potentially important opportunity to think more broadly about what staff at your business value. If you’re now panicking at the thought of staff leaving en masse, or taking industrial action because you can’t afford the pay rises they want this year, there may be something wrong with your employee-value proposition.

Most research suggests that salary is not the be-all and end-all for most employees. They want to work for organisations whose values they share and where they feel they have opportunities to develop and progress. Offering that kind of culture is important at any time, but this year, when people are focusing on pay, it could be the difference between keeping staff and losing them.

David Prosser
Business Columnist

David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.