After a prolonged period of stagnant growth, wages are beginning to rise again in the labor market.

The Bureau of Labor Statistics (BLS) recently reported that the average hourly wage rose 10 cents in December 2016 and 2.9 percent year-over-year, which is the largest increase since 2009. In addition, OMNI Human Resource Management (OMNI) has observed that overall pay in the labor market has been growing by 2 to 3 percent annually depending on the type of job or function being performed.

Wages appear to be rising as unemployment is dropping and as many labor markets or geographic regions approach full employment. However, wage growth still appears to lag the overall economic recovery, and forecasters still project slow wage growth for the foreseeable future.

Slow Recovery

But even with average hourly earnings rising from 1.7 percent in 2014 to 2.9 percent at the end of 2016, critics argue that wages are still below par. With an inflation goal of 2 percent and productivity growth of 1.5 percent, experts suggest that average wages should be rising by 3.5 percent annually.

Economists also say that inflation-adjusted wage growth is still not where we saw it in the 1990s and early 2000s, and we have years of slow wage growth now to make up for. Automation and globalization are key factors that have held wage growth down longer than in previous recessionary cycles.

Strong Growth Predicted

However, a sea change may be upon us. Experts are predicting that average wages will continue to increase at a faster rate. They believe the labor market will continue to tighten and overall inflation will remain relatively modest.

These experts also argue that wages are a lagging indicator and that they have not fully reacted to the 2016 labor market. As such, workers in the highest-demand fields—engineering, high tech, health care—will benefit the most from increased wages at a faster rate than others.

So, what can we conclude? First, rising wages and full employment will make it harder for employers to retain and attract strong talent, increasing pressure on their bottom line. This may be even more true for certain in-demand skills, especially in sectors like technology, engineering and health care.

Second, pressure on annual merit or general pay increases is mounting, again bringing increased pressure on the bottom line.

Third, uncertainties around the Affordable Care Act place a greater burden on companies to be more creative with respect to compensation, benefits and all other rewards. Creativity in managing the mix of total rewards, along with other nontraditional elements of the employment offer, will be necessary to chart a financially viable course forward.

Employers Must Adapt

There are several steps you can take to adapt to these changing circumstances.

First, consider raising compensation for consistent high performers and critical-skill employees. You could provide more aggressive base pay increases for high performers, or provide performance-based bonuses and incentive compensation payments, or a combination of both.

To fund these increases, consider reducing the amount of base-pay increases to underperforming employees or those who are otherwise competitively paid for the value they deliver.

You might also consider incentive compensation payments in lieu of base-pay increases. This avoids the compounding growth of base-pay increases while still providing valuable reward opportunity for all employees and top performers, particularly if the incentive compensation payments are tied directly to employee performance—higher risk, higher potential reward.

In this scenario, high performers generate more aggressive rewards because of the value they create for the business, while underperforming employees naturally earn less because they have created less value. This approach works particularly well in environments that embrace high performance and clear line-of-sight employee goals.

Lastly, pay careful attention to non-compensation opportunities to retain and motivate key talent. These opportunities include, but are not limited to:

• Career development and opportunities for employees to develop new skills or work on special projects. This enables engaged and proactive employees to enhance or expand their experience and capabilities, therefore enhancing their overall value.
• Flex-time or remote work opportunities. This allows motivated and focused employees to create a more desirable work-life balance (and higher productivity) while strengthening their commitment to the organization.
• Greater emphasis on total rewards—compensation, benefits, recognition—and adjusting the mix of these elements to address overall employee needs—medical benefits, retirement benefits, etc.
• Philanthropic and community service opportunities that provide employees an opportunity to give back to the community while encouraging teamwork and enhancing the company’s overall image in the community.

Each of these opportunities, and others like them, provide opportunities to address important employee needs while balancing the overall financial investment in talent. Generally, employees appreciate their employer’s willingness and flexibility in engaging with them to address their concerns and interests, strengthening their emotional commitment to the organization.

Budget season is almost upon us. The time is now for employers to weigh these opportunities and to plan and budget for high-leverage tactics that will attract and retain strong talent and deliver high return on their employee compensation investment.