- Written by: Patrick Bollinger
- Created On: 2023-10-11
- Last Update: 2023-10-11
There are a lot of assumptions floating in this article, please bear with them as I try to convey my thoughts.
Have you ever wondered, "Why are salary increases so high when switching jobs?" I have and what I have determined is that salary increases when switching jobs need to be higher than your typical raise, assuming all else is equal. The reason being, you will come into the new job off their typical review cycle.
For example, say a company performs their annual reviews on the second week of January, and you joined the company in February. Most likely, you will get an annual review the following year because your tenure is close to one year at the company. But, what if you joined in September? If you joined in September, you would only have 4 months of tenure at the new company, so it might not be enough time to warrant a full review. So, your review is delayed until the following year, and your salary remains the same for the 1 and 1/3 years. We will put aside the ideas of, "Couldn't the employer give a raise without a review," for now since I suspect that is atypical. This is just one example, but how long could you remain at your current salary?
This is why I believe salary increase can be so high when switching jobs. It's in the best interest of the employee to maximize their salary potential because it will remain stagnant for at least 1 year to probably 1.5 years. This also triggered thoughts of when determining a salary for a prospective job, think of the value of money in the future rather than value of money today. Inflation goes down at times, but mostly it goes up, so we have to make sure the value we are receiving for our work is not decreasing as time goes on. Which brings me to the other half of my musings, raises.
How should you think about raises for an existing job? It's not perfect, but I'm developing a mental framework as we approach review season. Taking the thougths from above, salaries accepted for a new job should be set for the future value of money, we should take the same approach with raises. But, what does that mean in practice?
For the past 50 years, the United States inflation rate is averaging 3.87% year-to-year. This data was calculated using the data U.S. Bureau of Labor Statistics' CPI for All Urban Consumers. Let us assume your salary at the time of review is $100,000 per year, to make calculations easier. Then, to maintain the same value that you are currently receving, your new salary should be $103,870 per year for the next year. I don't think we should stop our thoughts here though, because most compensation adjustments are tied to performance since "tech is a meritocracy".
Given that 3.87% is the average inflation rate, what does it mean if you get a 2.5% raise as an employee? At this point of time, to me it indicates that the value you are producing the business is lower than it was a year ago. This is counterintutive though, because you have gained a year of specialized knowledge about the company you currently work for. There may be other factors, like the business is not making as much money this past year, but should that warrant the non-verbal expression of, "We value you less," now?
Following is a rough table that you could think about when it comes to discussing your raise:
| Inflation Rate Factor | Company's Opinion of You |
|---|---|
| < 1 times | The company does not value your contribution to its growth. |
| >= 1 times but < 2 times | The company values your contribution but is not invested in your personal growth as much. |
| > 2 times | The company values your contribution and wants you to grow with the company. |
These are very rough ideas, and maybe not the right numbers, but the main idea is a company that gives you raises higher than inflation sees you as valuable and wants to give you more buying power so you can grow with it.
The last question you might be thinking of is, "How do I determine inflation rate?" Assuming you have been using future value of money to determine your salaries, then you can sum the month-to-month inflation rates since your last compensation change.
There are many factors when it comes to compensation and preceived value. This is only one factor, so please don't lose sight of the other things your company may offer. As an example; if you were paying out-of-pocket for health coverage and then, in the midst of your first year, your company covered 100% of your health coverage costs, this would likely act as a raise. In this example, I wouldn't expect a raise much larger than inflation because my buying power was increased from not needing to pay for health coverage.
What do you think? Am I being to "Eat the rich" with my thoughts? Most software engineers are in a fortunate position to have a good salary compared to their friends and family who are not in the field. I do believe we produce a lot of value based on the growth of many tech companies, so why not spread it?
Addendum 1: Opportunity Cost
On Code Youngtown's Slack, a member reached out raising the point of opportunity cost/loss for the employee who does not switch. They also made an analogy was made about landlords limiting rent increases per year to how much it would cost for a tenant to move to a new apartment. These are both interesting items to evaluate and I felt it would be good to post about it here since I had too many thoughts for a Slack message after thinking about it for a couple hours.
To summarize what I'm about to write about, I feel opportunity cost is too complex for the point I was trying to make in my original post about thinking of future value of money. I also feel opportunity cost is probably too subjective to have clear conversations about, I could be wrong about this though. I do feel it's important to raise and to discuss the different facets that make up opportunity cost. Lastly, I feel my original post only scratches the surface of one facet of opportunity cost.
Opportunity Costs for Employers
I liked the landlord/renter analogy, but maybe not for what it was intended for. I feel the landlord/renter relationship is a good analogy for thinking about the employer side of opportunity cost. As an employee, we are the "landlords" of our time and employers are our "tenants". Employers pay us every so often to keep renting our time. If employers feel they don't need to rent our time anymore, maybe because they found cheaper rent, employers can let us go (bare with me as I gloss over labor laws). If we feel employers are not good "tenants", we can stop renting to them.
Following are two examples that demonstrate different opportunity costs for employers. For each example, there are three people that the employer is thinking about:
Scenario 1: Specialized Domain Business
Imagine you work for an employer that operates in a niche market, in this niche market you need specialized domain knowledge that takes 6 months to achieve, and it takes 6 months to find the right kind of candidate to thrive in the environment. The opportunity cost for this employer is $50,000, 6 months of the recruiters time plus 6 months of low/no productivity from the potential engineer who needs to be on-boarded. Given the specialization needed, it may also be important for the engineer to have English as their primary language. In this scenario, the opportunity costs may be too high for an employer to consider switching to the contract engineer.
Scenario 2: Consulting Business
Imagine you work for an employer that does generalized software consulting, in this market you only need to know how to code so up to 3 months is needed for on-boarding, and it takes 3 months to find the right candidate. The opportunity cost for the employer is $25,000, 3 months of the recruiters time plus 3 months of low/no productivity from the potential engineer who needs to be on-boarded. The employer is likely to break even in the first year and save money in future years by no longer renting your time.
Conclusion of Opportunity Costs for Employers
These are only a couple of examples and not fully thought through as I'm trying to wrap up this post before work. However, I believe it's important to think of how opportunity cost can create a ceiling for any form of raises. If it's easy to replace you in the role, so the employer's opportunity cost is low because they are looking at global employee markets, then inflation rate won't matter since the game is being played on a different playing field.
Opportunity Costs for Employees
As the Code Youngstown member pointed out, there are many factors that create opportunity costs for employees:
I agree with all of this but I also feel it is hard to quantify most of it, besides higher pay.
Following is a modified sigmoid function as an example, where the X-axis represents "Your Salary As Percentile for Your Location" and the Y-axis represents "Percent Chance That You Would Look for a New Job Based on Salary Alone". I believe it's fair to say that the lower pay you make, the higher chance you will have of looking for a new job. I also believe it's fair to say that these percents will never be 0 or 100 because of the non-quantifiable opportunities raised.
As an example, if we assume everyone gets raises at the same time, and nearly everyone is getting the same raise of 1x inflation, but you get 2x inflation. Then, you will move to the right on this graph and likely feel less of a need to switch jobs.
I agree that I have missed out on how to capture job market opportunity in the original post, but it's tricky given the nuances of remote work and unique local labor markets. Perhaps thinking about raises in terms of where you end up on the Percentile chart can help but I worry about the artificial lowering of wages when other driving factors, like inflation, should be increasing them. As an example, if all employers keep wages the same even when inflation was 5% for the past year, then your percentile doesn't change but your buying power decreases.
TL;DR
Opportunity Costs for Employers may be the ceiling for a raise while Inflation Rate may be the floor for a raise. If your next raise is below the floor and/or the ceiling is below the floor; you probably should look for a new job where you are valued more.