Salary Budgets Are Flat—But Jobs and Skills Are Changing Fast

Diana Scott: So there are a number of different skill sets that actually count equally or almost equally as AI skill sets. And you need to reward people that are delivering value to the business, and that's what it really comes down to. Employees experience inflation personally, and we acknowledge that. But companies have to price labor competitively.

Steve Odland: Diana, your team has recently published this new study called US Salary Increase Budgets 2026-2027. Title that just rolls off the tongue, Diana. Yes. Welcome to the show.

Diana Scott: Thank you for having me.

Steve Odland: Yeah. So where can our listeners find your new study here?

Diana Scott: They can find the study online. The headline for this study really is that, Salary Increase Budgets, which is, yes, a very exciting headline and a very exciting title.

Steve Odland: But they can find it at tcb.org?

Diana Scott: Tcb.org, absolutely.

Steve Odland: If you look under Centers, it's the Human Capital Center, and it should be right at the top there.

Diana Scott: It should be right at the top. And we've been doing this report for 41 years, which is why we keep this title the same because it is a classic title for anybody in compensation in the HR field.

Steve Odland: And for everybody in finance who are trying to figure out how to plan for the coming year.

So 3.5%. Talk about how the study was done. These are hundreds of companies and a lot of input goes into this. It's not just a number that comes out of thin air.

Diana Scott: No. We've done this for 41 years, like I said. We typically have between 300 and 400 respondents. It's a rather long survey, very detailed. Participation is high every year. Compensation experts and professionals are very eager to participate because they want the data from this.

Steve Odland: Yeah. It's Really a great study, and we're going to get into some more detail on it.

But let's do talk about the top line. So what does 3.5% mean? There's a big range around that, isn't there?

Diana Scott: There is. 3.5% means it's pretty stable. It's been 3.5% for a couple years right now. So if you look at 3.5% you might say, "Okay, what does that really mean?"

It's pretty consistent. And I think you have to say there's got to be some cost discipline across the organization. But 3.5% doesn't mean that things are static. I think it means that it's a time for differentiation, too, and that's the difference there. It doesn't mean that everything is the same.

Steve Odland: An interesting point here is that the range in the study to whatever 95th percent confidence level is three to four. So it means that there is some differentiation across different function skill sets people, right? So it's not just everybody peanut butters it at one number.

Diana Scott: Absolutely. There is a range and also typically when you look at that 3.5%, the merit is actually projected at 3.1%. And then there's this other category, which is about half a percent. But you're right, the average is 3 - 4%. So there is differentiation and it is not a 3% or 4% increase for everybody.

In fact, you're going to see a lot of people are going to be thinking very carefully about how do I actually spend those 3-4% of dollars on my employees this year.

Steve Odland: Yeah. You talk in the study about skill set recognition too, and one of the hottest topics is AI. And we'll talk more about it, but there seems to be some degree of added reward for people who are adept at AI. They're really important skills in a company right now.

Diana Scott: There is added reward for people with AI skills. And in fact, in our research there was a whole section where we asked specifically where is there a premium paid for additional skills? Where would you pay for additional skill sets?

And there's a compensation premium paid for AI skills at 37.8%, and that's what people cited. But I think you shouldn't look at that and say, "Okay, that's exactly what we're going to pay for AI only," because right behind that is a premium paid for leadership skill sets and management skill sets at 30.7%, and beyond that, data science.

So there are a number of different skill sets that actually count equally or almost equally as AI skill sets. So skill sets are very important, but it's not just AI skill sets that count now.

Steve Odland: And you're talking in the aggregate anyway. It's different by company, but AI technical skills are rising to the top, which isn't surprising since those are the huge growth areas.

Diana Scott: Yeah, and I think what companies need to do is they really need to step back as they're looking at their organizations, business leaders need to step back.

They need to say, "What is my business strategy? Which capabilities are going to drive growth? Which are going to drive productivity, customer value, innovation, transformation over the next three years, five years? Which individuals are going to bring that, and how am I going to reward those individuals?"

So that's really what we're looking at, and if there's skill sets associated with that, yes, reward those skill sets. But it's not particularly AI skill sets. It's do I have AI skill sets that are actually delivering value? It's not the AI skill sets in particular, it's what they're delivering, and that's what we really need to think about rewarding.

Steve Odland: And it, again, it depends on what industry. If you're in the AI industry, you're rewarding technical skills. Some of these comp packages for those folks are just out of this world. If you're in manufacturing, it could be people who are adept at deploying AI and robotics and so on and so forth. It's a different flavor depending on where you sit.

Diana Scott: Exactly. As a business leader, you have to keep coming back to where am I delivering value, and who are the people that are delivering value? And you need to reward people that are delivering value to the business, and that's what it really comes down to.

Steve Odland: Now, one of the key challenges that I think most companies are facing is how do you grow? And we're in a higher inflation-- 3.5% inflation-- era, while at the same time it's almost no growth or sub 1% growth for most people, that aren't in the AI industry.

Diana Scott: Correct.

Steve Odland: It's a huge challenge to make that equation work when you're growing your costs and you're not growing your top line. How are HR professionals dealing with that?

Diana Scott: You mean the inflation versus you have a 3.5% budget? As an HR individual, you really do have to acknowledge that your employees are dealing with inflation.

You have to acknowledge that they have that lived experience certainly. Their costs are rising. At the same time you're right, the cost of labor is going up, and that really is the cost of labor, the cost of goods, everything has to be anchored to that from a business perspective.

So you really have to just as a business person, you really have to anchor yourself to those expenses.

Steve Odland: Yeah, and you've been a huge advocate of CHROs and human capital professionals wearing the business hat and partnering with their finance for finance groups. Because you can't do this in a vacuum.

So everybody wants to reward your people. You want to match inflation because that's what they're facing. But at the same time, you've got other constituents here, namely your owners or shareholders. You've got to produce the results.

So it's a delicate balancing act.

Diana Scott: It is a balancing act, and I think you just have to remind yourself that, you know, employees experience inflation personally, and we acknowledge that. But companies have to price labor competitively. And this is what we're doing. We're going out and we're saying, "How do companies experience labor competitively?"

That's what this research report really does. It anchors it to the competitive environment. And I will also remind everybody that when you say this range is 3.5% on average, 3-4%, the merit increase is really about merit.

It's not about a CPI. It is not a cost of living increase. It is about merit. And organizations really need to think about the merit portion of this, 3.1% on average, as a merit increase. And it should be distributed from a merit perspective rewarding performance. And then that other category should be distributed to deal with things like promotions.

Steve Odland: Equity.

Diana Scott: Equity, other, you know-

Steve Odland: Yeah.

Diana Scott: You know, all the...

Steve Odland: Other adjustments ...

Diana Scott: Need for skills and other things like that. Sure. So it is not cost of living. It's a sad reality, but it's the reality. As a business, you have to deal with the competitive environment.

Steve Odland: You also pay for promotions, and you want to make sure that-

Diana Scott: You have to because you have to. You exist in a competitive environment. And you have to think about, how do I retain and engage and acquire the kind of talent that I need to be competitive in this current environment?

Steve Odland: Which also means that maybe the balancing act is you do need to take action or act differently for those people who are not performing. It's not just a numbers game, but it's a productivity gain. And make sure the organization is as effective as it needs to be.

Diana Scott: Exactly. Because that is going to be the best for the business going forward and also for your employees who are in the business and are productive and are delivering what they need to deliver, and that's going to be the healthiest for your business going forward.

Steve Odland: Now, another thing organizations can do and have done in the past is to take head count out.

Let's just address it straight on. But we're sitting here at nearly full employment. I don't know if people remember this, but the number that we used to use economically was that 5% was full employment, you could never get better than that.

And here we are today near 4%. It means that the labor market is tight despite the inflationary environment, so you want to be careful to retain talent. This is a COVID learning, right? We got rid of a lot of talent, and then we had to go recruit it back at higher prices.

And that's fresh in our memory. So that's the other flip side of it.

Diana Scott: It is. What's really interesting though, we discovered in this report that the findings said that only 31% expect headcount growth and 9% expect reductions. But if you look at that top line, what it really misses is the movement underneath, because companies are restructuring. They're automating, they're upskilling, they're talking about selectively hiring for critical skills, they're talking about reducing work in other areas at the same time.

What we're seeing is that even though things may look static and the workforce may look like it's not getting bigger or smaller, it is becoming very different. And so I think there's a lot of movement underneath the surface that may be missed, which is making this a very interesting story.

So to your point, you have to be very careful about rewarding the people who are developing the skill sets or have the skill sets that are really adding the value that you need as you make these changes underneath the surface in your workforce that we're seeing and that are indicated by some of the other findings in this particular research report.

So yeah, on the surface, it looks really like there's not a lot happening. It looks pretty calm, pretty static. But then you start to dig into some of these numbers and you say, "Wow, there is a little bit of undercurrent that when you dig into it, there's a lot more happening here than meets the eye."

Steve Odland: A lot of stuff going on.

For a while you couldn't pick up a newspaper without reading that AI was going to kill jobs. Everybody was afraid that they were going to be gone. In fact, that isn't happening. There are some AI job displacements but there are a lot of AI job gains.

So this underscores your point that even within the narrow slice of the AI subject world, it looks steady, there's dynamic change.

Diana Scott: Exactly. An organization could start the year and end the year with basically the same headcount, but they could have materially a very different mix of work within their organization, different roles and different capabilities that they need within that organization, which to your point, could be driven by how they're using technology, potentially even AI, to change workflows, to change how work gets done, which in essence is really exciting. I think the message to employees and to managers is as you leverage these technologies as an employee, it should serve you very well if you begin to get fluent with some of these new technologies.

Take advantage of what your employer is offering you. Upskill yourself, reskill yourself. Be open to this, because it will open up opportunities for you.

Steve Odland: Yeah, and it's interesting that you get to the concept of change, and the majority of people will say, "I love change."

Diana Scott: It's not true. They don't.

Steve Odland: They do as long as it's somebody else that has to suffer it. Because it's hard. It's stressful. Change is stressful particularly when there's unknown, changes that could impact somebody. But, you and I were there in the era when PCs were dropped into the workplace for the very first time. Before that, it was 100% manual.

Diana Scott: I was?

Steve Odland: I was. I don't know about you.

Diana Scott: Are you revealing my age?

Steve Odland: I didn't do that, no. But it reminds me of that era when everybody was afraid, "What's going to happen?" And you remember you got these little beige boxes and..

Diana Scott: I remember when email was, became a thing.

Steve Odland: Yeah, and

Diana Scott: We were all like, "What is this email thing?"

Steve Odland: And you're always afraid of what the latest and greatest either digital evolution or workplace evolution will do to your jobs. But in fact, it has made workforces, people more productive. Just think about automation of assembly lines.

People used to sit there and screw in a taillight all day every day, and in fact it's all automated now, freeing people up to do higher order work. So at a certain level, you understand the fear but we all need to kind of take a deep breath on these things and get through it.

But it does, it puts some pressure on the human capital organization to help marshal all this.

Diana Scott: It does. It gives the human capital organization a huge opportunity. But they too need to see it as an opportunity, and they too need to upskill and reskill themselves to be able to drive that change through the organization.

I think CHROs have a huge opportunity to really step in and help drive that change through the organizations. And if they partner with CFOs and the CEO, they can really be a very powerful force to help the organization really rethink their whole ways of working. When people talk about the future of work and the opportunity to really change their whole operating model, the way they actually structure themselves, the process of working, the ways of working, CHROs can play a fundamentally enormous role in helping the organization through that and helping them in the managing that change in the organization.

The final thing I would say around that is the leadership required to push that kind of change through the organization is huge, and thinking through the kind of leadership that you need and how to develop that kind of leadership, recognize it, and then develop it is huge, which is probably why you see the skill sets that are valued and being rewarded through this, in this compensation report.

Yes, 37% goes to AI, but that 30% going to leadership and management skills, that's a recognition that is just as important, and you need to reward those skills, Because those are going to be equally as important as all this change and disruption happens within organizations.

Steve Odland: And speaking of leadership, one of the things you and I have learned over and over again in our careers is that the communication piece of this is so important.

The natural tendency is to keep all this quiet, confidential, don't explain anything, whether you're talking compensation, merit increases, whatever the number is, because, it's a kind of a secret. It's tense. But in fact, these are adults.

People understand if you can explain to them the reality. So if you're in a situation where your business isn't doing well and you can't hit the average, or whatever your situation is. You've said over and over again, it's better off just explain it, share with your people what's going on, lay it all out for them, and there will be better acceptance and enrollment in the concept.

Diana Scott: You are absolutely correct. That is always the case. Authenticity, transparency wins every time. Every leader that approaches a situation like that with authenticity and transparency earns the trust and respect of their employees. And trust is fundamental in any situation, especially situations that are difficult ones.

And if you can earn the trust of your employees, then they will then feel the-- I would call it-- the psychological safety to then really believe you. If they feel you're authentic and they can trust you, then they will believe what you say the next time and the next time, and that goes a long way then.

Steve Odland: Yeah. People probably listening to this going, "What does this have to do with salary increase budgets?" These are emotional kinds of subjects that need some explanation. I think what we're saying is that the leadership needs to start, obviously in the C-Suite, the CHRO, the CFO, but it needs to be cascaded down so that managers can communicate the reasons why, share with their people, and gain acceptance of this.

You don't just lay it on them. You have to work it and build that confidence.

Diana Scott: I think rewards have everything to do with communication and frankly, emotions and honesty and trust, and you have to be absolutely transparent about that as well. And people get very emotional about their compensation, and if you can put the rewards in context and help people understand how it is connected to their performance and that they are really being rewarded, that this is a reward for what their contribution is, and you can demonstrate that and they see that is really happening within their organization.

It has to be authentic, though. They have to see that happening within their organization. Then they will see that's connected to the business and their contribution.

Steve Odland: This is an important point, also on total rewards. So it's not just about salary increase budgets. It's not just about the merit. It's not, as you've said, it's not just what's happening in the external economy and inflation and all that. You've got to put all of this in the context of total rewards. So there's an opportunity here as part of this communication to present the whole package.

Okay, this is one slice, which is your base salary, but look at all these other pieces. And the total rewards package is usually 30-35% higher than base and bonus. So you've got all of this going on and should be communicated in context.

Diana Scott: Exactly. And frankly, nowadays, total rewards should be all-encompassing because many employees, they look to compensation, especially base pay, as sort of the table stakes, and they're looking for a lot more from their organizations.

They may look to development as part of their total rewards. Do I have opportunity within this organization? Am I going to be mentored and developed? Do I have a career path here? To them, that's part of total rewards. Things like even flexibility, that's a total reward to them. Sometimes they value that more than certain other things.

Their total benefits, 401, that's part of total rewards. So as managers think about communicating that, they have to think about the total package.

Steve Odland: One of the things that came out in your study is that roughly two-thirds of the organizations just rely on salary-based or job-based salary ranges.

And this goes back to the old Hay points or the bands and so forth. But as you look at this today, how should companies be thinking about modernizing their pay structures? Because again, it's not just about what the budget is, it's about the whole construct.

Diana Scott: Yeah, I think you can't abandon job-based pay because I think jobs still provide that architecture right now for the benchmarking and the governance and the equity, so we can't just walk away from it.

Job descriptions definitely need to be updated right now so that they reflect some of the current work. You have to begin to layer in some of the new skills, and that will be happening, especially those skills that really are adding value, that are really contributing to productivity or the skills that are particularly scarce that you need, that you value and you're looking for.

And maybe create new roles where those skills are at a premium. You might begin to create sort of hybrid roles, but I think you're still going to have a structure where in practice it's going to end up still being jobs, but it's going to be jobs plus skills supported by, you know, some kind of clear governance.

I think you're still going to end up having basically job-based structures.

Steve Odland: Earlier you were talking about the various pools. You've got salary adjustments, but you were talking about other adjustments, so there's promotions, equity, critical skills. Let's call that a strategic adjustment pool. How do you recommend people put a strategic adjustment pool together and govern that and implement that?

Diana Scott: It sounds like a small pool when you think about merit being 3.1 out of the three and a half, and maybe a half a percent.

I think we call it, 0.5% to 0.7% might be the other on average. But in actuality, it actually can be quite substantial depending on your organization. So most of it really needs to be thought of as a promotion pool because you really, as you said earlier, you really need to think about who are the folks in your organization that need to be promoted.

You do need to put governance in place so that it doesn't become who has the manager who has the loudest voice. So you do need...

Steve Odland: There needs to be a fair process ...

Diana Scott: There needs to be a fair process in place to think through that promotion process. Each organization has to figure out what that looks like depending on what their management structure looks like.

Because you don't want it to be just, "Hey, I get to promote my friends because I'm whatever by fiat because I like this person."

Steve Odland: Or you shout the loudest, yeah.

Diana Scott: You shout the loudest.

Steve Odland: Yeah. That's gotta be different than that. Final area that you talked about with executive salaries, that's a whole different conversation.

But in this case, it's governed by the board of directors through the compensation or talent committees directly. And bigger part of executive compensation is variable pay, and lower portion is the fixed pay. A lot of boards are, in fact, not giving merit increases or annual adjustments to base salary because they're relying more on the variable comp. Just talk about now in this brave new world that we're in, how should boards be thinking about all that?

Diana Scott: If you look at annual and, in particular, long-term incentives, which are really where most of the executives' compensation is focused-- AIP, when we looked at the study executives, typically the target was at 40%, CEOs was at 100%, sometimes that's a lot higher.

We don't see a lot of change in terms of how boards are looking to compensate or the metrics that they're looking by which they compensate. They're typically still very financially focused. If you think about where they're focused on, I think it's 67% are saying their financial metrics.

And I think the financial foundation is probably not going to change. I don't think that we want to see anybody rewarding things like the use of AI, or I think you do not want to reward things like pilot volume or adoption alone. I think you need to define measurable value first.

If boards need to think about how they apply AI-enabled productivity and workforce transformation, they need to really connect the AI, the executives' incentives, to actual output. But I think 79% said they use financial measures for executive AIP, and I think that's compared with 29% using operational measures and 23% using strategic or non-financial goals. I don't see that changing a lot.

Steve Odland: Yeah. But the point here is it needs to be a little bit more strategic, and it needs to be more long term and more variable. And I think your point is that's not changing anytime soon.

Diana Scott: No. If you can reward the value created by transformation and think about what are those values, what would the transformation represent, how do you measure that transformation, as opposed to just activities that were about transformation, then those are the metrics that I think the board should focus on. It shouldn't be about the fact that the transformation activity occurred.

Steve Odland: Your new report is called the US Salary Increase Budgets, and it's again, at tcb.org under the Human Capital Center. Diana Scott, leader of the US Human Capital Center, thanks for being with us today.