I’m not sure how it happened, but understanding that there is a difference between cost of labor and cost of living seems to have become the sole purview of compensation professionals. That would be fine if I didn’t see the term “cost of living” getting thrown around like beads at a Mardi Gras parade.
On the one hand, it’s great that folks are demonstrating that they know not all cities have the same labor market – they’re at least halfway there! It’s the context in which they’re using this term where things get confusing. Let me show you the secret comp handshake on this and welcome you as honorary members of the Poindexter Comp Club!
Cost of labor vs. Cost of living, in a Nutshell
First, the technical stuff. What exactly do these two terms mean?
“Cost of living” refers to the costs to a consumer in a specific geographic area. It reflects the price of food, housing, groceries, transportation, taxes and entertainment. Simply put, it’s the cost of maintaining a certain standard of living.
“Cost of labor” refers to the difference in pay or labor market for a job from one location to another. Another way to phrase this is that the cost of labor is what a particular geographic market offers as the “going rate” or compensation for its jobs.
Cost-of-living rates can be far greater than cost of labor. Cities such as Boston, New York and San Francisco quite frequently have this situation. The difference between the two costs can be attributed to the desirability of these cities. Lots of people live there, there is high demand for housing, food, entertainment, etc., so this equates to high prices for consumers. It is also possible that cost-of-living rates can be lower than cost-of-labor rates. Oil and gas companies are often good examples of this, because they’re typically located outside of a metropolitan area and have high competition for scarce talent.
Why It’s Important to Get These Terms Straight
Why shouldn’t we be throwing around these terms willy-nilly? Well, if your organization’s compensation philosophy is targeted to market-competitive rates of pay, then all you should really care about is cost of labor. Sure, you can recognize that there will be a cost-of-living difference when employees move to a new city, but if you are talking about their rate of base pay in relation to that move, you should be talking cost of labor only. The conversation would go something to the effect of, “We’ve evaluated your base pay in your current city relative to the labor market in your new city and….” By adjusting pay to cost-of-labor data, you would be aligning employee pay with appropriate rates for adequately recruiting and retaining talent.
In companies that have a market-driven compensation philosophy, if you were to adjust the compensation of relocating employees based on cost of living, that company would be at risk of overpaying or even underpaying employees relative to the labor market for their job. Also, most companies do not have a compensation philosophy that promises to support an employee’s lifestyle (cost of living). If you know of any companies that do and are located somewhere by a beach that never sees snow, please let me know.
Adjust compensation based on cost of living, and you run the risk of overpaying relative to the market.
Yeah, sure, if I’m being relocated to New York City, I as “Michele the Employee” want to know what my housing costs are going to be and how much my monthly expenses are going to change. Cost-of-living data is going to be very handy to me as an employee. But “Michele the Comp Professional” working at a company with a market-driven comp philosophy is going to be using cost-of-labor data for advising on employee pay related to a relocation.
I’ve only scratched the surface here on this topic. We could have a complete comp jamboree here if I started talking about the fact that cost of labor could actually vary job by job, or what to think about in situations where the relocation is employee- (not employer-) initiated, or even where to get your hands-on data sources.
Well, come on now. I said at the outset I was only making you honorary members of the comp club, not the president!
Tell Us What You Think
Does your organization’s compensation philosophy focus on cost of labor or cost or living? We want to hear from you. Tell us your thoughts in the comments.