Target compensation investments at the roles and talent most critical to the business.
Key takeaways
Expand total rewards beyond salary to support engagement when budgets are tight.
Build pay structures on reliable market data to strengthen transparency and equity.
Middle market organizations cannot afford to wait for compensation budgets to loosen. Inflation, tariffs and energy supply chain disruptions continue to squeeze the resources available for pay increases, while shifting workforce dynamics and artificial intelligence-driven hiring add further complexity. At the same time, employees are basing their expectations on the larger pay increases of recent years as inflation continues to erode their purchasing power. These pressures are reshaping compensation planning, making across-the-board salary increases unsustainable and leaving some employees without a pay increase.
Organizations need a more targeted compensation strategy that directs limited resources where they will have the greatest business impact. Strengthening variable pay, optimizing total rewards, prioritizing retention investments and grounding pay structures in reliable market data can help organizations support pay transparency, equity and long-term workforce needs without relying solely on larger salary increases.
Practical strategies for managing pay
View RSM's latest webinar, “Managing pay when budgets can’t keep up,” to learn practical strategies for strengthening total rewards, retaining talent without across-the-board increases and aligning pay structures with transparency and equity requirements.
Economic pressures strain pay budgets
Economic and workforce dynamics have remained in flux since 2020, challenging organizations to balance rising costs with employee expectations. Inflation, energy supply chain disruptions and tariffs are adding to these challenges.
Energy supply chain pressures are fueling inflation. Energy commodity costs rose 40% from May 2025 to May 2026, driving up the cost of moving goods by boat, car or plane. According to the U.S. government, overall inflation stood at 4.2% in May, down from a 2022 peak of 9.1% but ticking back up after a period of decline. Preliminary June data showed inflation around 3.5%. Continued uncertainty in the Middle East and global energy disruptions are contributing to the pressure.
Tariffs add another layer of complexity: New tariffs of 10%–12.5% across most countries from which U.S. companies source goods are affecting sourcing decisions on a larger scale.
Together, these pressures are intensifying the strain on pay budgets.
Workforce and employee dynamics reshape compensation planning
Workforce trends and employee expectations also shape how organizations approach compensation planning. Although these factors vary by company, industry and geography, they remain critical for organizations seeking to stay competitive while managing compensation costs.
Key considerations from the employer’s perspective include:
Hiring senior talent: Employers are focusing on hiring senior employees rather than entry-level and paraprofessional staff, disrupting the college-to-workplace pipeline. Senior talent also commands higher salaries, increasing compensation costs.
Expanding AI-driven recruitments: AI is likely contributing to fewer entry-level positions as organizations use it for work traditionally performed by junior employees. Some large technology companies are also shifting portions of future labor budgets toward AI investments.
Managing AI adoption costs: AI deployment requires retraining and creates transition costs, including potential severance when roles are eliminated. Coding, customer service, marketing and information technology appear to be among the functions most affected, with AI agents increasingly performing some of that work.
Slowing job creation: After a sharp postpandemic employment rebound, job creation has fallen below the pace of the 2010s. This shift adds to the challenge of balancing changing workforce needs with competitive compensation.
For back-office functions, employers are increasingly deploying AI as well as hiring overseas talent, outsourcing or bringing in vendor partners.
Deanna Balkcom, Director, RSM US
Key considerations from the employee’s perspective include:
Past pay increases shape expectations: In recent years, pay budget increases of 4%–9% were not uncommon, with 4%–5% more typical. While employees may use those increases as a benchmark, particularly as inflation rises again, maintaining that pace may not be sustainable amid ongoing global and regional challenges.
Inflation affects purchasing power: As purchasing power declines, organizations should acknowledge employees’ concern and explain why current pay increases may differ from expectations or previous increases.
When organizations don’t explain the why, employees create their own narrative; and that narrative may be inaccurate, affecting morale, trust, retention and engagement.
Ian Ziegler, Senior Manager, RSM US
Because managers play a critical role in performance, compensation and promotion conversations, organizations should equip them with talking points and a list of frequently asked questions so they can answer employees consistently and confidently. Managers also should understand the broader business objectives so they can explain the rationale behind compensation decisions. When employees understand the rationale, they are more likely to accept difficult decisions.
Redesigning incentive pay to reward performance
Recent RSM US Middle Market Business Index (MMBI) research suggests organizations are using a range of compensation and benefits strategies to attract and retain talent. One notable trend is the growing emphasis on performance-based incentives, with many organizations expanding incentive plans alongside traditional pay increases.
Decision makers are shifting wage and salary spending toward performance-driven variable pay to manage compensation costs. For example, a company might reduce the base pay portion of total compensation while increasing short-term incentive pay from 5% to 10%, giving employees greater earning opportunity tied to business performance.
Performance measures include profitability, productivity, revenue growth and other business priorities. When designed well, this strategy rewards employees when results support the added spend.
In addition, organizations are moving from discretionary to calculated incentive plans as more compensation is put at risk. With these plans, employees know exactly what to achieve for a specific payout rather than relying on subjective, year-end decisions. This clarity matters more when 10%–15% of annual compensation is at risk.
This calculated approach often requires building a return on investment into the plan design so it can self-fund, incorporating expected returns into financial forecasts and using measures such as earnings before interest, taxes, depreciation and amortization (EBITDA), revenue growth, margins and customer satisfaction, depending on business priorities.
Communication is key: Employees should understand how the incentive plan works and how performance translates into payouts. Discussing the plan at least at a high level several times a year, through firmwide town halls or manager-to-employee conversations, helps ensure it achieves its intended impact.
Optimizing total rewards beyond salary
Benefits are typically the second-largest investment in employees after payroll. These investments have a meaningful impact on engagement and retention, particularly when salary increases alone are not an option.
As open enrollment approaches, reevaluate:
Benefits: Review utilization, employee needs and available market offerings. Throughout the year, reinforce value through short webinars, manager talking points, benefit spotlights and reminders tied to life events.
Workplace flexibility: Consider options such as hybrid work, compressed workweeks or Summer Fridays to support work-life balance.
Wellbeing: Assess financial wellness and literacy, mental health support, and caregiver benefits, including elder care.
Beyond benefits, employers can support retention by creating opportunities for employees to learn, grow and build their careers. Career development, however, does not always mean promotion. Even in periods of flat or slower growth, employers can foster development through stretch assignments, cross-functional projects, job shadowing, mentoring, cross-training and certifications. Regular career conversations, timely feedback and AI skills training can help employees see a path for growth and prepare for future workforce needs.
Recognition matters just as much, particularly when budgets are tight. Employers should tailor recognition to individual preferences, whether through manager conversations, small rewards or public acknowledgment.
Prioritizing retention investments
When budgets are limited, organizations should prioritize employees by retention risk:
- Nonregrettable turnover: The departure of low performers, difficult personalities or disengaged employees poses less business risk and opens opportunities for others.
- Regrettable turnover: The departure of top performers, employees with critical skills such as AI, high-potential talent or future leaders poses greater business risk and hurts productivity, morale and growth.
Identify the most critical people across functions through workforce planning, candid conversations and leadership calibration.
Following this assessment, prioritize pay increases and retention incentives for critical employees, future leaders and those with internal or external pay gaps. When increases are limited to 0%–1%, consider these retention tools:
- Cliff-vesting stock awards: Provide awards that vest after three or four years.
- Enhanced incentives: Increase incentive payouts for critical, high-performing talent.
- Employee input: Survey critical talent to understand which retention incentives they value most.
Avoid one-size-fits-all retention strategies and assess whether employees feel satisfied with their pay.
Strengthening pay transparency
Pay transparency should go beyond compliance, particularly for multistate employers. A clear compensation philosophy, supported by market data and benchmarking, helps managers explain pay decisions and makes compensation and performance conversations more productive.
Inconsistent salary ranges can create equity concerns, particularly when pay decisions are not aligned with employees’ roles or market data. Pay transparency does not create compensation problems; it exposes existing issues, such as inconsistent salary ranges and pay decisions that are misaligned with roles or market data.
In addition, pay differences within the same role do not necessarily indicate an equity issue. Differences may be supported by legitimate business factors, including relevant experience, education, performance, skills and level of responsibility.
Decision leaders should assess whether pay gaps are explainable and consistently applied. Where gaps cannot be supported by job-related factors, employers can prioritize the highest-risk or largest disparities and address them over multiple compensation cycles.
Regular reviews of job descriptions, responsibilities and market alignment are also important, particularly as technology and organizational needs reshape roles.
Building a market-informed pay structure
Pay structure design empowers organizations to advance compensation compliance, consistency and equitable treatment. However, an effective pay structure should be grounded in a compensation study—not in assumptions about the market.
A compensation study begins with accurate, current job descriptions and reliable market data. Market comparisons should reflect relevant factors such as geography, industry and organization revenue. Comparing this information with current employee pay shows how practices align with the market.
Decision makers can then design a pay structure that reflects their compensation philosophy and determine whether employees are positioned appropriately within established ranges. In years with limited pay budgets, employers may need to prioritize critical roles and key talent, with a plan to move other employees toward target pay levels over time.
While compensation studies have traditionally been conducted every three years, the appropriate cadence depends on how quickly the market is changing. In fast-moving industries, organizations may need to review market data every two years or more frequently.
To begin, organizations need accurate job descriptions, a clear view of their desired market position and access to high-quality compensation survey data. Free data and AI-generated estimates may not provide the depth or reliability needed to determine market value accurately.
A proactive approach to compensation planning
As economic, workforce and regulatory forces continue to reshape pay expectations, a targeted compensation strategy—not larger budgets—is what will protect retention, equity and compliance going forward.
Within the middle market landscape, integrating variable pay, total rewards and pay transparency into a single, intentional compensation strategy strengthens retention without requiring larger budgets. This includes prioritizing critical roles, communicating the rationale behind pay decisions and grounding pay structures in current market data.
Ready to get started? RSM’s advisors can help organizations design competitive pay strategies, strengthen total rewards and build pay structures that support compliance and long-term growth.
RSM contributors
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