When we asked HR leaders about the most important factor affecting their increment decisions, most mentioned the organization’s previous year performance. This was before the COVID-19-induced lockdown in March. COVID-19 changed quite a few things and the approach towards deciding increments might just be one of them. Per the Workforce and Increment Trends Survey by Deloitte*, increments in India fell from 8.6 percent in 2019 to 3.6 percent in 2020. Organizations that are expecting to be affected more by COVID-19 have been more cautious in adding to their fixed costs. Increments in 2020 have largely been a function of expected, rather than past performance. Will this trend continue?

Much like other COVID-19-induced changes, there are three opinions on whether this change will sustain itself. The first category believes that whatever is happening in 2020 is the new normal. The second believes that 2020 is a black swan event and we will go back to normal as soon as this is over. And the third believes that our approach prior to the lockdown was sub-optimal; what’s happening right now is anything but normal and that we need to find a new, more balanced solution. Defining a solution for the third category, which is the most relatable, could turn into crystal gazing, but let us try anyway.

Back to basics

To understand the possible future of increments, we go back to the fundamental reasons why organisations offer them. The first reason is to compensate employees for rising cost-of-living expenses (as measured by inflation) to ensure that their purchasing power does not fall. The second reason is to adjust employees’ compensation for a rise in productivity that comes from enhanced skill and experience. Lastly, increments are also given to reward employees for their contribution to the firm’s success during the previous year.

Let’s start with inflation. Both Consumer Price Index and households’ expected inflation are currently above the upper limit of the Reserve Bank of India’s comfort zone. One would expect that a slowing economy would lower inflation; however, it has been stubbornly sticky so far. The good news is that most forecasters expect India’s inflation to taper down and while forecasts are, well, forecasts, this has an implication on long-term increments as the two are positively correlated (which is why developed economies see low single-digit increments). If the likely inflation trend is anything to go by, increments in India could continue to fall; something that several organisations have started factoring into their cost estimates.

The macroeconomic theory suggests that long-term real wage growth is determined by increased productivity amplified through the access to capital and technology. While this is good in theory, it works differently in practice. Technology can make jobs redundant as well as productive. Moreover, individual productivity is a function of opportunities, and not just skills. A growing organisation can offer better career opportunities, distilling into wider responsibilities for employees, who get to take up larger roles leading to a rise in their productivity, thereby justifying a higher pay. This is more common in high-growth start-ups where scaling-up is followed by huge financial rewards and relatively younger employees are given leadership positions. So, as far as long-term increments are concerned, organisational performance is likely to matter more than individual performance. An organisation that does not grow, may need to choose between its employees, leading to heightened internal competition, hampering collaboration in the process.

Increments are also used as a reward or an incentive. The idea is simple, if the organisation had a good year, it can afford to pay more. This trickle-down approach is usually not the most efficient as it considers what an organisation can afford to pay rather than what it should pay. It also assumes that past performance will repeat itself. Increments are changes to fixed pay (costs), which are generally decided after benchmarking compensation with a comparable talent pool. For roles where the supply of talent exceeds demand, organisations could instead offer a higher bonus rather than increments, as they can replace such employees at a lower cost, if required. This is where the human angle comes into play. Organisations generally like having an “in-it-together” approach and don’t like letting-go, rehiring, and retraining employees unless absolutely required. This also gives a sense of security to employees and leads to fewer difficult conversations. However, when the business hits a rough patch, the employees who are replaceable at a lower cost are generally the first to be asked to leave. So the party usually ends at some point.

The most likely way forward

A post downturn year is usually characterised by significant employee movements—employees who are sitting on bottled-up frustration may crave for change and look for new opportunities. In the short-term, organisations could respond by offering off-cycle increments and/or retention bonuses. However, over a longer horizon, given the expected trajectory of inflation, double-digit increments seem like a thing of the past. Increment budget decisions are likely to be top-down rather than bottom-up. As budgets remain tight, increments are likely to be tilted towards the top 15–20 percent employees who don’t just have a proven performance record, but also the potential to take up next-level roles. There could also be greater functional differentiation based on the talent pool availability. Roles that augment traditional know-how with technology are expected to continue to command a premium. Very few organisations, ones that are cash-rich and are continuously growing, are likely to offer high increments to all their employees.

Brace yourself for higher inequality, also known as pay-for-performance

The Future of Increments in India