In a recent series of posts Jeff Hawk discussed compensation challenges of sourcing talent, affinity, and purchasing power in "How Does Your Job Offer Stack Up?" Adam Silver followed with a post where he discussed “Attracting Talent,” which focused on one of the challenges that companies face within the U.S.—attracting talent to what are often perceived as “dying” cities. Now, Michael Joyce delves deeper into affinity and the potential impact when it doesn’t exist between a home and host location.
What is affinity?
When comparing two locations, affinity refers to the similarity of pay and taxation structures. In a cross-border move, it refers to the similarities and stability of the two economies and currencies.
When transferring or hiring employees for a permanent position domestically or to a new country, companies often have a default approach regarding the policy and the compensation and benefits practices that apply.
Host rate of pay - does this approach work?
The most common approach of multinational companies is to place the individual onto the host rate of pay, based on a combination of market data and existing salary structures. In many cases this works well if the employee is aligned to the salaries of peers in the new host location and receives a salary net of host taxes and social security.
But it doesn’t always work so smoothly. Employees will always compare their net pay in the new host location with the net pay they received in the previous location.
If the move is within the same country, the net pay after tax may be the same or there could be minor regional variations in taxation. But even with little or no taxation changes, the purchase power of the net salary may still differ. For example, housing costs are very different between London and Nottingham in the UK.
Moves often do not succeed where there is no level or a low level of affinity between the new host and previous home location.
Case Study - Berlin to Warsaw
Let’s take an example of a company seeking to transfer an employee from Berlin, Germany earning EUR 90,000 to Warsaw, Poland with a host market salary of around PLN 320,000 or EUR 70,000.
Using the AIRINC Salary Evaluation Tool we can calculate the person would have netted out an equivalent of EUR 65,000 when home in Germany. The new offered salary of an equivalent EUR 70,000 will net down to around EUR 46,000 after Polish taxes.
So, at first glance, we can assume it will be difficult to persuade the employee to take a lower salary with a net reduction of almost EUR 20,000. If this is a key talent, the immediate impulse would be to increase the host gross salary until it reached at least home net levels. However, if we dig deeper into the calculation, we can also determine the purchase power in Warsaw is much greater than in Berlin. While taxes are proportionally higher, housing is around 28.5% less expensive and goods & services are 26% less expensive. This means the original offer of EUR 70,000 will provide around the same cost adjusted purchase power for this employee.
While there may be some affinity between Berlin and Warsaw from a geographical and culture perspective, there is not a great deal of affinity when comparing purchasing power, but we can still make it work. Instead of focusing only on the after-tax net pay, looking at other calculations can aid decision making and demonstrate to the employee that the new offered salary has the same purchase power as the previous home salary.
After tax analysis - don't lose key talent!
Without this type of after-tax analysis, we run the risk of losing key talent because the employee believes they will be in a worse position if we don’t increase the offer. We can also have a situation where employees accept a move based on the new host net being higher than at home. However, when they arrive in the new location, they find the cost of living is far more expensive, and the new net does not have the same value as it did in the home country. The first thing they tend to do is knock on the door of the compensation department to point out they are at a disadvantage, which is a conversation that could have been avoided.
There will be some locations where it is very obvious that affinity will not exist. For example, it will be very difficult transferring someone on a permanent basis from Dubai, UAE, which has a very low tax rate, to Oslo, Norway with a high tax rate and a higher cost of living. There is no affinity from either a tax or purchase power perspective and the cultures are also very different.
Some companies develop an Affinity Matrix, putting the various salary and tax structures side by side to determine when a transfer makes sense from a net compensation perspective. If you go one step further and insert the cost of living elements, you will find the true net, after tax, goods and services, and housing. You will need to create your own acceptable range, plus or minus X%, to decide if the transfer makes sense and is likely to be accepted or not.
Impacts of exchange rates and inflation
While the net compensation affinity approach may work, it can still be hard to persuade an employee to accept a permanent relocation if the host country experiences high inflation or frequent severe exchange rate fluctuation. Clients may also have to provide education support for children of employees particularly where the net pay is lower or similar to home, but there is little cultural affinity, meaning the local school system would be too difficult for their children to integrate.
Non-compensation factors such as culture, language, and political environment are important elements to consider when determining if a transfer to a new host location makes sense based on the home and host traffic pattern of the transfer.
Ultimately, this type of affinity analysis provides powerful information to facilitate permanent transfers so that costly or unnecessary administration or mistakes are avoided at the outset.
Stay tuned for more case studies in the coming weeks that illustrate real-life examples of affinity and purchasing power. In the meantime, please contact us if you would like to learn more.