The real cost of the living wage

The new UK national living wage of £7.20 an hour is coming. But who’ll benefit, who’ll be paying for it and will HR be caught in an organisational crossfire of conflicting interests?

Lynn Young is a production operative at fresh produce supplier Produce World, helping to package up fresh fruit and vegetables from a factory in Cambridgeshire. She is one of around 800 people across the organisation who will receive the increase to the national statutory minimum wage rate of £7.20 per hour from April next year. She is also among the millions of UK employees chancellor George Osborne addressed when he announced the introduction of a national living wage in this summer’s Budget, declaring that “Britain deserves a pay rise”.

Young is underwhelmed. “£7.20 won’t make a fantastic difference but it will make things better for me – I won’t have to struggle so much when it comes to shopping,” she says. “I will be able to buy slightly better-quality food instead of going for the cheap stuff that is high in salt and fat.” The increase, although comparatively significant to historical minimum wage rises, still won’t allow her to afford ‘luxuries’ such as holidays, and she still worries about how proposed cuts to tax credits will affect the lower paid.

Young’s employer, like every other organisation in the country, is now busy calculating how it will afford the increase. Tesco chief executive Dave Lewis has gone as far as to call the living wage, coupled with soaring business rates, a “lethal cocktail” that will mean shops could close and jobs might be on the line.

“A significant proportion of our workforce will be affected by the rise,” says David Frost, Produce World’s group HR and organisational development director. “We’ve done our calculations and think it will increase costs by around £1 million per annum between now and 2020.” The company will meet the costs in various ways: from investing in technology that can handle some manual tasks typically done by low-paid workers, to reducing its dependency on agency staff.

The figures on these pages, taken from a CIPD survey of more than 1,000 employers across the private, public and voluntary sectors, paint a picture of confusion over the implications of the living wage, both culturally and financially.

The survey found that employers are divided over how to manage the higher costs brought about by the national living wage, with almost a third (30 per cent) planning to deal with it by improving efficiency, while 22 per cent intend to absorb costs. But 9 per cent said they would reduce hours, and 8 per cent are planning to take on more workers under the age of 25.

Meanwhile, research by PwC suggested that a third of respondents plan to pass the increased costs on to customers, while 26 per cent said they would reduce headcount.

“This is a great opportunity for HR to show its value to the business, start a conversation about better job design and improving the organisation, and challenge cost-cutting through lower bonuses or profit shares, or reducing allowances or out-of-hours payments,” says CIPD chief economist Mark Beatson. “Anything above the statutory minimum you can shave away. But employers need to be careful. They need to think, do we want to do this, or are we doing this just because we can? It may help save costs but employees will spot what’s happening, which could affect engagement.” 

John Harding, employment tax partner at PwC, says businesses should take this opportunity to step back and consider their strategy. “Do they need to reskill people, to switch roles around? Or do they need to look more fundamentally at all elements of reward?” he asks. “You can increase your revenues either by getting your existing employees to be more productive, or by raising prices. And if you want more out of staff, you need to look at your business model.”

This is one of the areas Produce World is considering, says Frost: “If we can upskill, make clearer career paths, perhaps consolidate some roles – so, for example, a factory operator has a more skilled job – it would mean fewer people on the bottom rate and more with higher skills and higher pay.”

But not all companies are taking such a long-term view. Some are looking to offset the pay increase through changes to contracts or other aspects of reward. “I think there will be both legal and illegal methods used to get round this,” says Jonathan Lord, lecturer in HR and employment law at Salford Business School. “We might see some organisations pay eight hours at the national living wage and then a lower rate cash in hand. Others will use legal approaches but will be crafty; for example by freezing recruitment, or by hiring people on a self-employed basis so they’re not covered by the national living wage requirement.”

The new national living wage could also have an impact on the demographics of certain workforces, given that it only applies to those over 25. In the social care sector, for example, where there is a high dependence on low-paid workers, employers may be forced to reconsider the age profile of those they recruit on the minimum rate to reduce their overall wage bill. But could this create a two-tier workforce, or even a wave of age discrimination claims?

“Equality laws provide a special exemption so that pay bandings do not contravene discrimination law,” says Tania Goodman, partner and head of dispute resolution at law firm Collyer Bristow. “However, this is susceptible to a challenge that it breaches European law – although so far this has not happened.”

Encouragingly, though, PwC’s research found that most larger organisations plan to keep a single rate. “I think this is for three reasons: they don’t have many younger workers; they think it’s too complicated and will affect other wage rates; or they’re concerned it could be deemed discriminatory down the line,” says Harding.

Whether there will be legal challenges or not in the future, the age banding could create issues for managers. Contract catering company Elior currently doesn’t plan to pay the new national living wage to under-25s across the entire estate, and HR director Arran McDowell says this could prove problematic where, for example, there is a 21-year-old supervisor in a team earning less than their more junior colleagues. In addition, the company has to be mindful of costs to clients and discusses wage implications with them on a one-to-one basis. “We have 2,179 permanent employees who are over 25 and the cost impact to us is around £2.3 million. In an industry like hospitality or catering, which has low margins already, that’s going to have a huge impact on the bottom line,” he adds. 

Age issues aside, a significant change to the ‘floor’ rate is bound to have an effect on other wage differentials in the organisation. This will mean looking carefully at rates just above the lowest level, as well as the distribution of pay across the organisation as a whole. To reach £9 by 2020, the national living wage will need to rise by 6 to 7 per cent per year, while average salary rises remain stagnant at around 2 per cent. “If those on the next wage level up see those below receiving a proportionately bigger rise, they may not be happy. HR needs to be mindful of how the increase is communicated,” advises Lord.

The experience of Nationwide, which pays the higher, voluntary UK living wage (as recommended by the Living Wage Foundation), demonstrates the importance of forward planning. “The roll-out affected three groups: directly employed staff, contractors and temps, and suppliers,” says Stephen Uden, head of corporate citizenship. “We found there was a small difference at the bottom end of the pay scale and worked closely with the reward team. We had all the data on how much people were paid, so we could calculate the impact at this level and higher up.”

Moving to the voluntary living wage rate meant there was a grace period so the business could communicate and embed the changes in advance. “We didn’t want to tell our department heads that they had to reduce their budget for the year and put up wages immediately, so we asked them to factor it into their resource planning for the next financial year,” says Uden.

Mindful of the impending increase in wage bill costs, several UK supermarkets have already announced they will top the national living wage, with Lidl moving first by announcing its staff would earn at least £8.20 an hour from October. However, it’s not out of the question that some of these employers will simply move their wage bill around, reducing other benefits such as pension contributions or bonuses to compensate, or hiring more people part-time so that paid breaks are not a factor.

“If you’re an employer like John Lewis that offers a generous performance-related bonus or pension, neither of which are counted in the minimum wage, will you choose to shift this around?” asks Duncan Brown, head of HR consultancy at the Institute for Employment Studies. “There’s lots of evidence to suggest that ‘skills pay’ pays off – that if you pay skilled employees more, the return to the business is higher as they’re more productive or you need fewer staff.”

Giving low-paid staff more responsibility will also be beneficial in the long term by improving retention and productivity. “Many employers will be looking past the idea of simply cutting jobs and hours,” says Robert Hicks, head of HR at software company Reward Gateway. “Those who earn the least are the most likely to leave for a small increase elsewhere, so by addressing this issue you are being proactive.”

Granted, investing in skills development and paying more will mean higher costs in the short term, but it will improve career prospects for lower-paid staff in the long term, and enable the organisation as a whole to move skills around more flexibly and become more competitive. “One of the problems in the UK is that we treat the minimum wage as the going rate, rather than a residual,” says Jill Rubery, professor of comparative employment systems at Alliance Manchester Business School. “We think of labour too much as a cost; employers need to be careful to build in opportunities to advance beyond that rate.”

And while there has been plenty of doom-mongering about the possibility of redundancies or fewer vacancies, experience internationally suggests that modest minimum wage rises do not necessarily equal a major reduction in job opportunities.

The job for HR, now, is to work with finance and managers across the organisation to see not just how the increase can be absorbed, but how the workforce as a whole can become more productive to make that rise worthwhile.

Look out for the levy

On top of the headline announcement of the forthcoming national living wage, Chancellor George Osborne also set out plans for a national training levy to be paid by large employers to support apprenticeships, due to be introduced in 2017.

The first consultation on the proposed levy ended at the start of October. The government’s intention is that organisations will pay their contribution through their PAYE return to HMRC, at a rate to be confirmed but which will be calculated on the basis of employee earnings. It’s hoped the levy will help fund three million new, high-quality apprenticeships by 2020.

A recent survey by the CIPD found that 39 per cent of people agree with the levy in principle, but almost a third (31 per cent) feel it could cause them to reduce their investment in other areas of workforce training and development. And given the timing of the proposed levy’s introduction, this is one further outlay organisations are going to have to consider on top of an increased wage bill.

Mark Beatson, chief economist at the CIPD, says this might not be the only additional cost organisations need to worry about: “We also have the apprenticeship levy for larger employers, and there is discussion about whether those employers that bring in non-EU migrants on tier-2 visas for skilled work will pay a levy. There’s also a planned increase to auto-enrolment contributions to think about.

“A people-as-cost mindset won’t produce the right business outcomes – success will come from investing and developing people to perform their best,” he added.

How to get your house in order

The new rate isn’t coming into force until April, but it may pay to start preparing now for a seamless introduction. 

  • “Start with the end in mind,” advises Deborah Rees, director of consulting at reward advisers Innecto. “It will be much easier to model this in one pass if you consider whether key pay elements such as overtime, out of hours payments, shift pay and allowances could be rolled in to help make the cost more affordable.”
  • Consider the wage bill beyond immediate staff. How will contractors be affected? Arran McDowell, HR director of Elior, says: “We started talking to our clients straight after the announcement.”
  • Look beyond the rise in April. How will you afford the incremental increases that will bring the minimum up to £9 by 2020? “We don’t know exactly how pay will change in the next five years, but the aim is to end with staff over the age of 25 earning a minimum of £19,000,” says Rees.
  • How do demographics affect the wage bill? “The rise only applies to those aged 25 and over. It’s time for a conversation about whether people of different ages should be paid differently for doing the same job. If there are good reasons for it, employers need to avoid breaking the law by ensuring their systems track each employee’s age and make sure they are paid the right legal minimum,” says CIPD chief economist Mark Beatson.
  • Delve into the differentials. Other, more senior staff may be concerned about their own pay rises or how pay differentials will be eroded over time. Or is the wage distribution too focused on paying more to managers and above? “Taking a step back to analyse the wage bill as a whole may unearth other pay gaps in the organisation, particularly between men and women,” says Beatson.
  • Think about reward as a whole. “You should look at the elements of how you pay people,” says John Harding from PwC. “Identify which elements count towards the minimum and therefore affect your compliance. You could have a higher basic rate but change bonuses, for example.” Employers should also be mindful of other costs coming down the line, such as increased compulsory pension contributions and the proposed apprenticeship levy.
  • Do you want to create a feel-good factor? Stepping up your bottom rate to the voluntary living wage (£8.25 an hour nationally and £9.40 in London) will mean staff can better manage the cost of living and feel happier about coming to work. And, as Duncan Brown of the Institute for Employment Studies points out: “If you stick with the national living wage, you’re allowing the government to set your rates.”